MRP 26: Investing in Mineral Rights and Royalties

Today we’re talking about investing in oil and gas mineral rights and royalties.

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Shout Outs

Accrued Interest says “Excellent – If you own mineral rights this is a podcast you must listen to.”

Mczhczh says “Great podcast – Loving the podcast, been wanting to hear about that topic as a petroleum engineer from CSM as well.  Would like to dive deeper into buying/investing in mineral rights for novices in a future episode.”

Mczhczh and several others have requested that we talk about today’s subject so hopefully this provides some useful information.

Before we get into today’s subject, I want to throw out a disclaimer.  We are talking about this topic for informational purposes only. There can be significant risk associated with oil & gas investing. The information discussed today for informational purposes only and is not a solicitation to buy or an offer to sell any security. The information discussed is not intended to be used as individual investment or tax advice. Each individual’s tax situation is unique so consult your tax advisor regarding current tax laws and their effect on your situation.  Also, investing in oil and gas properties is not suitable for all investors and should only be considered by those who can withstand the loss of the entire loss of the investment.

If you need a refresher on the difference between minerals and royalties please listen to Episode 2 of The Mineral Rights Podcast.  It would also be helpful to listen to Episode 4 where we talk about how minerals are valued.

So, as you may know the drilling boom across the US has caused mineral rights and royalties to become a much sought after investment by individuals and private equity companies.  The upside of minerals and royalties is that you get to invest in oil and gas wells without having the burden of drilling or operating costs. Given the booming economy over the past few years, many investors want exposure to this market at an attractive price and minerals can fit this bill.

That said, this interest in mineral rights in certain hot plays like the permian basin, has caused prices to go through the roof.  Anecdotally, I’ve heard of offers upwards of $25,000 per Net Mineral Acre in certain parts of the Delaware Basin (for minerals with 25% royalty) (as of late 2018).

Who are some of the big players:

EnCap is one of the biggest energy investment powerhouses who has gotten into minerals. They have spent over $1 billion in mineral investments. Another big boy is Blackstone Minerals who has invested over a half-billion dollars. (Source: Bloomberg)

There are countless other private equity firms out there investing as well and many oil & gas operators have created their own minerals teams to invest in minerals in addition to operating oil & gas wells.

There are several other types of investors out there as well, from speculators and landmen who look to buy minerals and flip them to other investors for a profit, to companies like Matt’s who generally invest in minerals for the long-haul across several basins to diversify and help spread the risk.

Pros and Cons of Investing in Minerals:

Pros:

• Tax advantages: Depletion deduction, selling an asset may fall into long-term capital gains
• Can deliver good returns if you buy at the right price and if wells either are drilled soon afterwards or if producing minerals, production continues at expected rates
• Unleased minerals can provide cash payment in terms of lease bonus before wells are even drilled you can earn some income. If lease expires, you might be able to lease again.
• Ownership of real estate under the surface of the earth.
• New formations and technologies being discovered all of the time, after the producing formation is depleted, another deeper formation might be found to be economic

Cons:

• Tax – lease bonus payments and royalties may be treated as ordinary income
• At the mercy of oil company as to when wells might be drilled on your land.  Also a risk that a well may never get drilled in your lifetime. You are a passive owner and don’t have a say as to whether or not to drill or when to drill a well.
• Commodity prices.  Oil and gas prices may be good when you buy but a downturn in prices could have a significant effect on your royalty checks.
• Have to be sophisticated investor and know what you are getting into.  Not for everyone. Need to invest in the right areas with the right geology and with an operator that will be around for a while to drill out your acreage in a timely fashion.
• Can be complicated to invest directly on your own, finding deals, doing proper due diligence from land/title side to running economics, have to know what you are doing.  
• Need to have a trusted team of advisors – lawyer, accountant, engineer
• You need to have enough funds and be able to lose the entire investment without it causing you to go broke.
• Another con are the cons – in other words, people who are out there soliciting investments in wells that they say they will drill and promising returns that seem too good to be true.  Be very wary of anyone who cold calls asking for you to invest.

What are the Different Ways to Invest in Minerals?

There are many different ways to get involved in minerals and royalties but we’ll just cover three of the most common.

First you can simply buy stock in a publicly traded pure-play minerals company (e.g. Black Stone Minerals). This is not an endorsement of Black Stone, just an example.

Another way is to buy into a Mineral Rights Investment Fund. Many companies that are active in the minerals space have funds where outside investors can participate.

Finally, you can buy minerals directly from private individuals or companies. From Energynet.com to sending out letters, there are a few different ways to do this. Read to the end of this article to find out some of the considerations when buying minerals this way.

Investing in a Mineral Rights Fund:

Caveat – You may need to be an accredited investor as defined by SEC.

• Do due diligence on company and the founders. What is their track record?  What basins are they investing in? Identify where you would like to invest (geographic area) – basic understanding of geology, risks, operators, etc.
• Need to understand the type of security you are investing in.
• Match fund with your individual investment goals, e.g. do you want a fund that invests in both producing and non-producing mineral acreage with both near term and 36-month time-horizon for when wells are drilled, identify targeted returns e.g. fund that looks for say 25% rate of return.  What is the exit strategy (e.g. in 3 years, 5 years…) How might low commodity prices affect their exit strategy?
• Look for investment with a minimum investment that matches your budget.  Consider the unit size (e.g. share price 10k/unit, $50k/unit, vs. $250k/unit). How big is the fund size (maximum offering amount)?
• Funds are often setup as limited partnerships.  If you invest, you will be a limited partner. Certain things that come with being a limited partner, talk to your attorney and accountant to understand how it might impact you.

How much are the management fees?

Company should provide detailed financial forecasts and state key assumptions.  If they won’t disclose this type of information, you need to consider whether or not you are comfortable investing.

Investing Directly in Minerals as an Individual:

• Before actually investing, setup entity to invest through, setup bank account, normal startup stuff – Consult with an accountant, lawyer, etc.

How to Find Mineral Rights Investments:

• Auction site like EnergyNet.com
• Mineral brokers
• Finding deals directly (e.g. contact mineral owners in target area directly)
• Either way – need to be able to do due diligence:
  • Valuation – How much is it worth?
  • Document preparation – agreement, deeds
  • Title search – verify owner and how much they actually own
  • Title curative – often minerals still of record in decedents name, need to put in sellers name.  Might need probate, determination of heirship, etc.
  • Handle closing – deed in exchange for $$
  • Post-closing – record deed, notify operators of change in ownership, request Division orders

As you can tell, there can be a lot involved with investing directly in mineral rights and the nature of the investment self-selects who is eligible.  Spans from buying shares in publicly traded minerals companies, to investing in mineral rights LP’s, to buying minerals directly from owners.

As with any investment, you should seek the advice of your accountant, financial advisor, and attorney to help you make an informed decision.

Again, this information is being shared for informational purposes only.

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