“What are my minerals worth?” This is the most common question posed by owners. The straight-forward answer is whatever someone is willing to pay or what the amount for which you are willing to sell. This probably isn’t the answer you were looking for, however. The question most mineral owners are actually trying to answer is: “Is this offer to buy my minerals fair?”
Calculating Mineral Rights Value
Underlying Value
Mineral rights only have value to the extent the underlying resources do as well. The underlying resources only have value if they can be extracted profitably. The current oil price environment makes profitable extraction impossible. Oil companies need oil prices of around $45 per barrel just to breakeven.
If a mineral company offers to buy your minerals in today’s market (writing as of April 2020), it means they are pricing-in a rebound in oil. If a rebound doesn’t happen, operators will continue to turn off wells and eventually go belly-up, making the mineral company’s investment a total write-off. As a mineral owner, you need to weigh this risk-reward. Would you prefer to sell today, shifting the risk of a ‘total write-off’ to the buyer? Would you prefer to invest your proceeds into a less-volatile asset? Or do you want to ride it out and see what happens, hoping for a price rebound?
This is the same risk-reward analysis that mineral buying companies perform. They make predictions about what the world will look like in the future and make investment decisions based on them. This is the same thing as gambling; mineral companies are making bets. Plain and simple. It is what every investor does on every investment, and is no different than gambling in Vegas.
Gambling on the Future
Most “professional investors” scoff at the idea that investing is akin to gambling. Gambling is something degenerates do. They, on the other hand, are “sophisticated”, which apparently allows them to perform some sort of mental gymnastic to justify that they aren’t gambling. This is just flat-out not true. Anything that involves predicting the future is gambling. Period. Full Stop.
Imagine you are sitting at the blackjack table and notice that a lot of small-value cards have been played recently. This means there is an increased likelihood you getting dealt aces and face-cards on the next hand. This, in turn, increases your odds of winning. As such, you choose to bet $50 instead of your normal $5.
The outcome in this example is not relevant. Its purpose is to demonstrate the process of betting on future outcomes based on current expectations. In this example, the expectation is that you have an increased chance of getting a blackjack dealt to you (an ace + a ten or face-card). The desired outcome is a winning hand. This is the exact same process that investors follow to make investment decisions. “I think XYZ is going to happen in the future. Therefore, I’m going bet XYZ happens. If it does, I end up with more money.” Sound familiar? Am I explaining the logic behind a bet at the roulette wheel or an investment decision? Trick question: it’s both.
The Bets
With every acquisition, a mineral buyer is making one or more of following bets, depending on the particulars of a given deal:
- Oil prices are not going to fall
- Wells are going to produce (i.e. not be shut-in)
- Future wells will be drilled
- Operators will not go bankrupt
For each of the above, a buyer weighs the risks against the potential rewards. His offer is ultimately a representation of the price he is willing to pay to take on these risks. For example, if an operator is staring bankruptcy in the face, the buyer will require a higher potential return to justify absorbing the risk. If he determines its 50/50 the operator goes under and the wells stop paying out as a result, he will be willing to 50% less than if there was no risk.
Another example: if there are no wells currently drilled, there is a chance wells never are drilled. And even if they do get drilled, it might not be for several years. This is why minerals that have drilled or fractured wells on them are worth significantly more than those without.
At the end of the day, it’s all about risk/reward.
Conclusion
Unfortunately, it is impossible to say minerals are “worth” $X. This is true for any asset or investment. Mineral rights (or any asset) are only worth what someone is willing to pay to own them, or what you are willing to accept to sell them. The price someone is willing to buy or sell is a combination of his predictions about the future and his risk/reward tolerance. This is also why you often see offer amounts that vary significantly from buyer to buyer. “Worth” is in the eye of the beholder
I recently inherited some “mineral rights” (in New Mexico). Does that mean I am a “royalty owner” too? Are those terms interchangeable?
HGW_56 – while those terms are often USED interchangeably, they should not be. You are always a mineral owner (unless you sell the minerals). You only become a royalty owner when you LEASE your minerals. The lease gives the lessee the right to drill your minerals, normally in exchange for an upfront payment and an ongoing royalty. You can own minerals that are not leased, in which you don’t own any royalties and are thus not a ‘royalty owner’.