The Crash
The U.S. benchmark for crude oil, West Texas Intermediate (“WTI”), traded for $63.27 on January 6, 2020. On April 20, 2020 it was at -$37.63 (yes, that is a negative sign). Oil is no stranger to booms and busts. However, the speed of the current bust is unprecedented. COVID-19 absolutely destroyed oil demand.
The world normally produces and consumes around 100 million barrels of oil per day. Estimates place current consumption at around 65 million barrels. Because production cannot be turned off as quickly as consumption, around 100 million barrels are still still coming out of the ground every day. The result is 35 million extra barrels of oil are entering the market. This oil needs to be stored somewhere. The world has limited oil storage capacity, which is close to filled at this point. With more oil coming out of the ground, but nothing to do with it and nowhere to put it, it becomes a liability instead of an asset. This has been driving the current crash and why prices dipped negative.
Impact on Mineral Rights Value
Make no bones about it, the oil price crash is bad news for mineral owners. It is not a perfect 1:1 relationship between oil price and mineral values, but obviously the two are highly, highly corrected. Mineral rights only have value if the resources in the ground also have value.
Producing Minerals
Royalty Check Impact
If you own minerals under producing wells, you will see the true impact of this crash on your upcoming royalty checks that reflect March and April production. Remember, royalty checks are paid in arrears so your most recent check likely reflected February production and oil prices (writing in April 2020). Oil prices fell approximately 50% in March compared to February. Setting aside the additional impact of decline curves for a moment, this means mineral owners should expect to see around a 50% drop in their March royalty checks compared to February. April is going to be even worse. Compared to February, oil prices are down approximately 85%.
If you were receiving ~$1,000 per month in your March and April checks, which remember normally represents January and February production and oil price (~$50), expect your May check to be around $500 and June to be closer to $150.
To appreciate the scale of this recent crash, at this point even if oil prices tripled, your royalty checks would still be less than 1/2 of what they had been pre-crash. I’m not trying to rub salt in the wound with the added emphasis here. I’m just trying to drive home the reality of the situation. If you were dependent on these royalty checks to cover certain expenses, you need to know what is coming and plan accordingly.
Mineral Value Impact
Because the present and future cashflows producing minerals generate have taken such a nosedive, minerals are now worth significantly less than they were just two months ago. This is unfortunate, but it is reality. Many mineral buyers calculate their offer for producing minerals as a multiple of royalties. Buyers will not base their offers on your January or February checks, however. Instead, offers are based on the future royalties that the buyer would receive, which are going to be significantly less than past ones. For your checks to return to pre-crash checks levels requires oil to immediately go up 500%, something no buyer is going to assume is going to happen in any reasonable time frame (and this is before we consider that production is also decreasing every month at the same time due to the decline curve).
Non-Producing Mineral Value Impact
Everything about the impact of oil prices on mineral values discussed above in the context of producing minerals is also true for non-producing minerals. However, non-producing minerals have an additional problem working against them.
Per above, an extreme excess of supply in the market caused this crash. Given such an excess, operators have no reason to drill additional oil wells. In fact, drilling an oil well is nowhere near profitable at current oil prices. Most U.S. operators need oil prices to be around $45 to simply breakeven. Even then, the world has to use start using up all its excess supply before operators will want start drilling again. Otherwise, excess oil again floods the market and oil and prices remain depressed.
Non-producing minerals get double-whacked. Buyers price in the risk that the minerals never get produced, or at least not for the foreseeable future. And if minerals do get produced, it’s likely going to still be at depressed oil prices. Something above today’s price, but no one is going to assume it’s at at $60+ oil prices.
Summary
Mineral rights only have value to the extent the underlying resources also have value. Further, the underlying resources only have value if they can be profitably extracted. 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), they are likely pricing-in a rebound in oil prices. 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 write-off. As a mineral owner, you need to weigh this risk/reward. Would you prefer to sell today, shifting the risk of a 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? No right or wrongs here…all depends on personal risk tolerances.
