Here at Petroleum Evaluations Group (PetroEval) we work with a large number of mineral owners. Many are of the opinion that you should never sell your mineral rights. They believe that you never know what the future may hold. Maybe there is more oil and gas on their properties than previously expected? If they sold now, they may not benefit from this future oil and gas production. This is a fair point. After all, if their ancestors had sold their minerals may years ago they would not be reaping the benefits today. Then again, the fossil fuel industry is not expected to continue to grow the same way it has in the past. Renewable energy, carbon taxes, a volatile global economy, and increased environmental regulation, could all contribute to a sharp decline in demand for oil and gas. Some mineral owners fear that their resources are in danger of becoming stranded assets: oil and gas that could be easily produced, but with no one to buy it. This has already happened to the coal industry. Coal reserves are being left underground as coal power plants across the country are being shuttered. It is very possible the oil and gas industry will eventually go the same way. Some mineral owners are already feeling this reality. In Colorado, where recent state laws have made it more difficult for oil companies to drill wells, mineral owners are at risk of having their mineral rights become worthless due to new environmental regulations.
For a mineral appraiser, it is hard to account for events that will happen far into the future, be they technological advancements that would result in additional oil and gas production, or a global shift away from fossil fuels. A mineral appraiser typically considers a time frame only 10 to 20 years into the future. They also assume the future will look a lot like the present. Anything beyond 20 years is so hypothetical that it is not worth considering. Furthermore, the concept of time-value-of-money (the idea that a dollar today is worth more than a dollar tomorrow) makes any revenue beyond 20 years from today have almost no present value. With this in mind, when do mineral rights have their highest value? If you are considering selling, when is the best time to sell?
An oil and gas property has its highest value soon after it has been “drilled-out”. Typically, a company has drilled-out a property when there are anywhere from six to 14 horizontal wells within a single section (square mile). Approximately three months after a property is drilled-out, a mineral owner will be receiving their largest royalty checks. This is why the mineral rights are most valuable at this time. At this point in time a mineral acquisition company recognizes that there is little risk in purchasing the minerals, and all the wells on the property still have a long production life ahead of them. This situation can be described as “low risk/high reserves.”
Every month after a property has been drilled out, the oil and gas reservoirs are depleted. As the oil and gas is drained, the mineral rights start to lose value. After two years of production, mineral rights can drop in value by as much as 50%. This is because modern horizontal wells (or “fracking”) have very rapid decline rates, producing most of their oil and gas in the first few years of their life. This situation can be described as “low risk/low reserves”.
Prior to a property being drilled out, a property still has a lot of oil and gas underground, but there is risk associated with producing these hydrocarbons. Before all the wells are actually drilled, no one really knows how these wells are going to perform. They may be gushers, but they also may be duds. This can be escribed as a “high risk/high reserves” situation. This situation presents some of the most complicated mineral appraisal challenges. Mineral rights can be worth a lot of money to some people, and not worth a lot to others. When this is the situation, there is a lot of room for negotiation with a potential mineral buyer. It is in these situations when it particularly pays off to hire an expert.
In conclusion, the timing of when to sell your mineral rights can be extremely important. When thinking far into the future, recognize that there is a chance that by selling your mineral rights today, future generations may miss-out on collecting oil and gas royalties. However, this oil and gas has may become a stranded asset if the oil and gas industry goes the same way as coal. If you do decide to sell in the near future, remember that mineral rights have the most value when they are already receiving royalties, preferably from a large number of horizontal wells. They lose value as oil and gas is produced and the underground reserves are drained. It is worth hiring an expert that understands the valuation process to negotiate with mineral acquisition companies on your behalf. The greatest room for negotiation exists when you only have one or two wells on your property, but many more likely to be drilled in the near future.
The graphic below, illustrates the topics covered in this article. Note that the highest value of mineral rights is soon after the property has seen significant amount of drilling.
