Many mineral owners will regularly get unsolicited offers to purchase their mineral rights. Often the offers are from small businesses that mineral owners have never heard of before. So, who are these mineral rights buyers? How do they come up with the numbers they are offering? And how can a mineral owner know if they are getting a fair offer?
When it comes to producing oil and gas, there are three groups of people involved. The first group are operating companies which raise the money to drill wells, select where wells will be drilled and then manage (or “operate”) the wells once they are producing. These operators have large budgets and are mostly companies you have heard of before such as ConocoPhillips, Nobel Energy or Devon Energy. The second group are oil and gas service companies. These are companies that are hired by operators to do the actual drilling of the wells along with other services such as hydraulic fracture stimulation (or “fracking”). You have probably heard of the larger service companies such as Schlumberger, Halliburton, and BakerHughes. Service companies do not actually produce and sell oil and gas, they simply get paid to drill the wells and provide other services. The third group are mineral rights owners. These are the people that have the right to the extraction of oil and gas from a tract of land. Most mineral owners don’t have the money or expertise to drill their own oil and gas wells, so they usually lease their mineral rights to an operator in exchange for an initial bonus payment and then a percent of future revenue in the form of royalty checks.
While many mineral owners are just regular folks that inherited their mineral rights from their family, there are also businesses that own mineral rights and purchase mineral rights as an investment. These mineral rights buyers typically do not need a large amount of money to stay in business. A mineral buyer may raise anywhere from several hundred thousand dollars to a few million dollars before going out to purchase mineral rights – a much lower investment hurdle than an operator that could be spending $7 million dollars on each well they drill. This is why there are so many companies out there buying mineral rights, and why most mineral owners have often never heard of them until they receive a purchase offer. Mineral buyers tend to be small businesses that pop up and then disappear based on how much money they raise from investors. Many are also focused on bundling together lots of mineral properties before selling them as a package to a bigger company.
The value of mineral rights depends on the expectation of future royalty revenue. If a property has many productive wells paying large royalty checks every month it will be more valuable than a property that has no wells at all. When someone sells their mineral rights, they are giving up is their future monthly royalty checks in exchange for one large payment today. When a mineral rights buyer makes an offer, they typically considered two things: the first is the ongoing oil and gas production from existing wells located within the property. The technical term for this is the Proven-Developed-Producing reserves, or PDP reserves. The second is the potential oil and gas production that could one day come out of the property from wells that have not yet been drilled. The technical term for this us the Proven-Undeveloped reserves, or PUD reserves.
Because PDP reserves are from wells that currently exist and are producing, the investment risk associated with them is low. Because PUD reserves are from wells that have not yet been drilled, the investment risk associated with them is high. After all, it is possible these wells will never be drilled and so paying for PUD reserves may result in throwing money away. There are also other reserve categories such as Probable Undeveloped, or Potential Undeveloped. These refer to oil and gas reserves that has not been proven to be commercially viable to extract and mineral buyers will rarely pay anything for these resources.
Mineral owners can get a good idea of what types of reserves they have on their property based on the number of wells that are paying them royalties. If there are a lot of wells paying royalties, then the property likely has been “drilled out” and has mostly PDP reserves. If there are only one or two wells paying them royalties, then the production unit could potentially accommodate additional wells and there would be some PUD reserves.
Mineral buyers make higher offers for properties that already contain a lot of producing wells and have PDP reserves. They make lower offers for properties whose value depends on operators drilling additional wells in the future and have mostly PUD reserves. Calculating the value of PDP reserves tends to be easier. As a result, mineral buyers tend to generally make similar offers for PDP reserves. Their offer letters may vary by only a few hundred dollars per acre. Mineral buyers tend to have more difficulty calculating the value of PUD reserves since there is a lot of uncertainty and risk about what the future will hold. Will an additional well be drilled next year? Maybe in five years? How much will that well produce? How much of that production will be oil and how much natural gas? These are all things that mineral buyers are considering and since they can only guess at the answers that are generally more cautious. As a result, mineral buyers tend to make a wide range of different offers for the same property when most of the value is associated with PUD reserves. The wide range of offers reflects the wide range of expectations from the different mineral buyers.
One mineral owner that recently worked with Petroleum Evaluations Group received in the same week an offer to purchase their mineral rights for $1,200 per acre and another offer for $3,500 per acre. This large discrepancy is not a result of the mineral buyers not understanding their business or trying to rip-off mineral owners. It simply reflects the level of investment risk that each buyer is willing to take on. The higher offer comes from a company that is more confident in the future potential of the property while the lower offer comes from a company that is more cautious.
A mineral owner can know that they are getting a fair deal by hiring a professional that can think like a mineral buyer. Successful negotiations for the sale of mineral rights occur when the buyer and the seller are both on the same page as to what is being valued and what are the investment risks. Petroleum Evaluations Group regularly helps mineral owners understand this complex valuation process and equips them with the knowledge they need to successfully negotiate the sale of their mineral rights.