Qestions re: Selling Mineral Rights

I am sure many current lease holders have gotten offers from third-party companies offering to buy all or a percentage of your lease out. Selling points often are taxation as a Capital Gain at 15% now versus as "Income" (28%-36%) for lease payments, money now versus potential money in the future, uncertainty of future drilling, etc. However, a close friend of mine who is in a production unit in Guernsey County told me that these companies are looking to get a ten-fold ROI (return on their investment) over twenty years when they buy people out. Granted the depletion rates average 65% over the first five quarters, declining thereafter, the current tech is only recovering 30% of recoverable energy, with the tech expected to improve in the coming years, plus other formations i.e. Marcellus, Trenton-Black River, etc. So, outside of a desperate current financial situation, it would be wise to hold. My question are: Does anyone have any info on the ten-fold ROI they seek? Even if it was double, that could be a significant amount of money. Also, I got a call from my lease holder Thursday making me an offer, and they just commenced drilling in my unit, so uncertainty is not an issue. I also have concerns regarding the uncertainty in our country right now, dollar/economy collapsing, geopolitical situations in the world, etc.

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Permalink Reply by RJ Morgan on November 23, 2014 at 2:58am

Thank you Phil- very helpful. About to leave for church, but will check this out when I get back.

Permalink Reply by Philip Thackray on November 23, 2014 at 3:11am

RJ,

Copy the column labeled "Northern WV-Dry Marcellus" to a column in a working spread sheet (the spread sheet that you downloaded is frozen).

Form a second column to the right of that column which is the running total of the first column.  If you copied the EQT data to column D with numbers starting at D7 then your first equation in column E (E7) with be = D7.  The equation in E8 will be =E7+D8.  Drag that equation down the rest of the spread sheet.  You now have the cumulative production of column D.

Once you have that done, I'll show you how to adjust the numbers to reflect the production numbers from the Porterfield C well.  Then we will make an adjustment for the "density" of wells as your unit has a higher "density" than the Porterfield C unit.

The dry Marcellus curve is the best estimate I can find and the per month format allows us to just sum the numbers as I describe above.  If we had an actual curve, we would have to compute the mathematic integral function to get the running total numbers.  My guess is that the Utica may decline faster than these curves given the high porosity.  But this is just a start.

Phil

1s7k1qp9wk1t7Permalink Reply by 1s7k1qp9wk1t7 on November 23, 2014 at 1:53am

All I needed for motivation to sell some of my mineral rights was presidential executive order dated December 16th 2012.........if the "king" decides it's in the best interest of the rest of his royal servants he can take away all of our mineral rights......look it up......you can find it in a search on the white house website.

Permalink Reply by RJ Morgan on November 23, 2014 at 2:28am

WOW- Will do Danny. Those are the kinds of concerns I alluded to in the beginning of the post. I am a watcher of things geopolitical, fiscal, monetary, etc. and I am not optimistic. The stock market is an enormous bubble hopped up on QE to infinity, the dollar's days are numbered, we have a corrupt oligarchy, etc. I could go on and on about these things, but things do not look good going into next year- under normal circumstances I would never sell any percentage, but this world is clearly not normal and getting worse by the day. A percentage now, reinvested i.e. gold, silver, food, etc., pay off debt, etc. or roll the dice and hope that life as we know it will continue past 2015. That EO would certainly enable them to extort us all and fund the madness.

1s7k1qp9wk1t7Permalink Reply by 1s7k1qp9wk1t7 on November 23, 2014 at 2:35am

Spot on RJ....couldn't agree more.  Throw into the mix that the tree hugging loonies want the almighty EPA to govern over fracking regulations and some governors want to bend the companies over with higher severance taxes and we could all be screwed

Permalink Reply by Tim on November 23, 2014 at 5:43am

Humans, by nature, consistently over-estimate the potential reward and greatly discount the known risks.  

Diversification is a greatly misunderstood concept.

We know whom ever owns the minerals when a well is drilled will be the one who gets the lion share of the profits from those minerals.  We also know that getting leased and getting drilled are two very different events.  With upside reward, always comes the risk of no or low reward, and opportunity costs and taxes of diversifying ones mix of assets.

At ADM Energy Partners, our default position is 1.  Holding your minerals for the long term is the best option to maximize your profits

2.  As the value of those minerals become a larger piece of the pie of the 'net worth' of the owner, diversification is an exercise that must be undertaken to objectively balance future risk/reward scenarios.  This means to view, on paper, current value, future value @ base case, best case, worse case, and impact to owner of liquidating a portion, or all of their mineral position.

3.  We then overlay the 'personal financial position' of the owner to recognize unique considerations for their decision.  We do not make decisions for owners, we objectively lay out the cards on the table, which naturally strips away the emotional impact on the process, and in most cases, allows the mineral owner to clearly see the economic choices on the board.  Its always their decision.  

4.  Then we proceed as requested by the owner/s to efficiently proceed with the chosen direction.

Permalink Reply by Philip Thackray on November 23, 2014 at 8:46am

RJ,

I wrote up a description of how I would analyze the Porterfield B E RCH BL that you are in.  I have done this before for wells that I am involved with here in SW PA.  I also included a built up spread sheet for the Porterfield B E RCH BL.  The description of what I did is below.  There should also be enough information for you to form your own spread sheet.

 

Copy the column labeled “Northern WV-Dry Marcellus” (from the spread sheet that I sent you earlier) to column D of a Excel spread sheet.  Form a second column to the right of that column which is the running total of the first column.  If you copied the EQT data to column D with numbers starting at D7 then your first equation in column E (E7) with be = D7.  The equation in E8 will be =E7+D8.  Drag that equation down the rest of the spread sheet.  You now have the cumulative production of column D.

 

Column E should look like this:

212,871

392,351

548,946

And so on…

 

Note that the label for column D is Mcf/month and the label for column E is Total Mcf.

 

Next we scale the production to match the Porterfield C well.  In 135 days the Porterfield has reached a total production of 1,314,861 Mcf.  135 days is 4.5 months.  Let’s call it 5 months as that will be a bit more conservative.  In the same time period the EQT sample well has reached 815,243 Mcf.  The EQT sample well is 4800’ long and the Porterfield well is 5000’ so I won’t correct for such a small difference.  So we can scale the sample well to reflect the Porterfield C performance by multiplying column E by 1,314,861/815,861 = 1.6 .  Create column F as 1.6 * column E.  The label for column F is Total Mcf.

Column F should look like this:

340,593

727,762

878,314

And so on…

 

Then we adjust the total quantity to reflect the total length of horizontal in the Porterfield C unit (5000’) and the total length of horizontals in your unit the Porterfield B E RCH BL unit 3x 7100’=21,300’.  Form column G as 21,300/5000 = 4.26 times column F.  This is the total Mcf calculated monthly for the wells in Porterfield B E RCH BL.  The label for column G is Total Mcf.

This should look like:

1,450,927

2,674,267

3,741,617

And so on…

 

Next we calculate an Mcf/acre by dividing column G by 506.5 the number of acres in this unit.  Create column H as column G / 506.5.  The label for column H is Total Mcf/acre.

This should look like:

2,864

5,279

7,387

And so on….

 

For an individual land owner to calculate the cumulative dollars the remaining required information is:

  1. Royalty percentage (expressed as a decimal ex. 16% = 0.16)

  2. Sales price of gas (assume no deductions)

  3. Total acreage in the unit

  4. Time period.

 

Just for fun I’ll make some assumptions just to get a ball park number.  In the first year the cumulative Mcf / acre (from column H) is 19,989 Mcf/acre.  Assume a 42 acre property, 19,898 x 42 = 835,716 Total Mcf produced by the 42 acres in the first year.  Assume a gas sales price of $3.00 dollars/ Mcf.  Then 835,716 x $3.00 = $2,507,148.00 the sales value of the gas produced by the 42 acres.  Assuming a 16% royalty, then $2,507,148 x 0.16 = $401,143.00 total to the owner of the 42 acres in the first year.  The per acre value just for the first year is $401,143.00 / 42 = $9,551.04 /acre.

 

To make a better estimate of the value of the future income stream the Present Value of the income stream can be calculated.  In Excel, the PV formula only allows for fixed equal payments so that does not work for us.  The NPV formula in Excel allows for varying payments.  If we assume that the income stream cost us nothing then the NPV calculation yields the Present Value.  Of course, the NPV calculation will require a discount rate.  I would note that it is possible to discount the production stream and apply sales price (if fixed) and royalty later.  This is because the NPV calculation is a linear function.  That is, NPV(a*X) = a*NPV(X) where a = a constant.  Remember that the discount rate must be entered as a monthly discount rate.

 

I created column “I” which is a monthly list of Mcf/acre-month which I then put into the NPV formula at J5.  This yields a discounted present quantity of future production.  I went out 20 years.  The discount rate can be entered at J4.  I have entered 0.0033 which is a monthly rate that works out to a yearly rate of 4%.  We can discuss this choice if you wish.

 

The number J5 is total (discounted) production for the next 20 years per acre.  To convert this to a PV in dollars, multiply by the sales price of gas per Mcf, then multiply that by your decimal royalty.  The $ number so obtained is the PV value of the income stream per acre at the entered discount rate and commodity price.  If you want to do this model with varying prices then you will need to make another column.

 

Phil

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Permalink Reply by RJ Morgan on November 23, 2014 at 11:04am

WOW Phil- thank you so much for your generosity, kindness, and time in working this up for me. I just read your description and need to look at it in depth, but very impressive. I am a bit rusty on spreadsheets but will take my time and work through it. You were very close in your estimations- I have 40.5 acres in the production unit, 16%. I have a bit over 43 total acres but since I am at the end of the unit it clipped that much off. Thursday the rep from AEP offered $11K/acre which came out to $469K- so even at $3 Mcf in your example, the one-year figure is not too far short of the offer, the assumptions being even with precipitous declines rates say of 65% in 15 mos (five quarters), it could prove to be hefty sum to give up in years two, etc. Thank you again- it is very appreciated.

Permalink Reply by Philip Thackray on November 23, 2014 at 11:16am

Jesse, RJ,

Your welcome.

Actually took a lot more time to write up than do the spread sheet.  I have been kicking this stuff around for at least a year.  I've posted similar analysis elsewhere on GMS but this was the most comprehensive.

The Present Value feature is what brings this to the real world "time value of money".

I'm out until tomorrow AM

Talk to you later,

Phil

Permalink Reply by RJ Morgan on November 23, 2014 at 12:46pm

Thank you again. I extrapolated those numbers based on my acreage for years 1-5, 10, and 20, but used Friday's market price since AEP was giving the valuation based on that. Wow. For everyone reading this- and granted, I used the same market price per Mcf for all the calculations (impossible to know in one month, let alone one year, five years, etc.) the total value over 20 years was not far shorter than a FIVE-FOLD return on what they offered (25%/year return over 20 years). Obviously there are so many variables that can't possibly be known, especially average well-head price year to year as both supply AND demand increase, the declining value of the dollar (lost 97% of it's value in 100 years), how long they will actually produce, new technology, etc. it at least gives some rough parameters. So, with that said, Phil has done us all a great service by at least putting mineral buyers offers in perspective as well as enabling we who stay the course to understand the impact of decline rates over time, ballpark ideas on what to expect, etc.

Permalink Reply by Nancy LeNau on November 23, 2014 at 1:55pm

Phil, I don't understand it all but I am very impressed of what you know and that  you took your precious time to help others !  Thank you and God Bless, Nancy

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