There’s no perfect way to value producing mineral rights. One quick and dirty approach is the “rule of thumb.” Those following the rule of thumb say that mineral rights are worth a multiple of three to five times the yearly income produced. For example, a mineral right that produces $1,000 a year in royalties would be worth between $3,000 and $5,000 under the rule of thumb.
Professional valuations are available for a price. For most mineral owners evaluating an offer to sell, the cost of the professional valuations are prohibitively expensive. A rough professional opinion from a geologist will cost upwards of $500. In my experience, most geologists follow some version of the rule of thumb.
As a lawyer, I am a fan of factor tests. This is type of legal analysis where a Court takes numerous factors into account to render an opinion. I think a factor test is a solid way to value mineral rights. How might a factor test look for a mineral right? Let’s try!
Factors influencing the value of a mineral right:
- What are mineral is being produced? Oil, gas, or both? Is the gas dry or wet? Dry gas is the least valuable, Oil more valuable, wet gas the most valuable.
- How much oil or gas is being produced over the most recent six months? How does that compare to the previous year? This a way to know whether the commodity produced is trending down, stable or trending up.
- Overall, how long has the interest been in production? Anything that has been in production for more than 6 years has had 80% of its oil and gas produced. Wells in production for more than 20 years are in danger of being shut in or plugged. That is the death of income stream! In some cases, a well drilled only 10 years ago can wind up plugged when the operating costs are too high.
- How much income is being produced? Interests that produce $1,000+ per month in income sell for a premium. Interests that produce a yearly check of $100 or less sell for a discount, if at all. Is the income going up, going down, or stable?
- What are the trends for the oil or gas price paid by the producer? Observing the data for the past six months, then the previous year gives a good idea of where the commodity price is headed.
- How long has it been since a well was drilled or reworked on the mineral interest? This is a good indicator of whether the well operator is serious about production or just riding the assets into the ground.
- Is there any potential to drill more wells? Most states have spacing regulations that dictate the maximum number of wells that can be drilled in a unit. Find out how many wells are in your interest’s unit. Can more wells be fit into the unit under existing rules?
- Any new activity in the area? Nearby drilling means there is potential for more income. This can cause the mineral interest to attain a speculative value that sells by the acre rather than based upon the income stream.
- What is the state tax environment? Some states do not levy an income tax. Others levy an income tax, property tax, and a severance tax. Mineral interests in states with a more favorable tax environment are more desirable.
So let’s say we have an interest making $200 per year in income that has been producing for 10 years. The trend in income is down for the past three or so years. The interest produces only dry gas. The production volumes are down 15% from three years back. The price of natural gas has been trending higher. There are no new wells or drilling in the area and there is no room for more wells in the unit. The State where the interest is has income tax, property tax, and a severance tax. What’s it worth?
Weighing the factors, the income stream is probably degrading (lower production volumes, no new wells, no room for more wells) but temporarily being buoyed by higher gas prices. It is a smaller, older interest in a unfavorable tax environment. Being older, there is a chance of shut-in or plugging. Based on this factor analysis, the valuation of the mineral interest would be on the lower end of the rule of thumb–maybe a bit less. Fair value could be $500 to $700.
If the same interest was in a State with no income tax, the interest might be worth an $100 or more. If there was room for more drilling and a strong upward trend in gas prices, then perhaps another $200-$500 more is justifiable. This is the beauty of taking a factor approach! We can assign some tangible value (negative or positive) to each factor.
What about mineral rights prices when there is new discovery? In my experience, that is a situation where all bets are off! When the first wells of a new discovery start coming in positive, minerals are typically sold at a per acre price rather than as an income stream. With new discoveries, I’ve seen prices in excess of $10,000 per acre for minerals that have never produced a drop of oil.
Disclaimer: I am not an appraiser, geologist, or reservoir engineer. The information provided is just a generalization I’ve formulated from years of buying and selling oil, gas and brine royalties.