Not a day goes by without various financial planners lamenting the dire state of the average American’s savings nest egg— the asset that should be seeing them through their retirement years in relative comfort.
I have to say that I have NEVER seen any information from anyone urging aging parents to compile and clarify their mineral estates so their heirs can make the most of the mineral estate they will inherit.
The generational transfer of mineral wealth over the next 10 to 20 years will be massive. I’m afraid in many cases it will be chaotic, uninformed, and incomplete. If I’m right, the potential for wealth destruction is huge.
Why do I think this? I’ve given several talks to royalty owner groups, ranging in size from 50 to more than 300 people. At the end of each talk, I ask the audience to raise their hand if they can confidently point out on a map where their minerals are located. If I get a 20% response rate I’m thrilled, because the number is usually less than 10%.
In my estimation, a large percentage of royalty owners probably inherited their minerals from their parents. They’ve been getting checks and mailbox money for years and probably assume that if they will their minerals as a cash-flow stream to their children, that’s good enough.
It’s not nearly good enough.
Having lease documents clearly organized for their kids and educating them about the important provisions within the leases that have been granted is crucial. If the heirs haven’t learned the intricacies of their leases—things like Pugh clauses, depth severances, continuous drilling provisions, and mineral reservations—through a thorough set of discussions, that’s a huge missed opportunity for empowerment.
Ignorance of basic principles on how oil and gas reservoirs behave over time can be costly. If neither the grantors, nor their heirs, have any concept of remaining recoverable reserves (RRR) they risk losing a lot of money. For example, it would be easy to imagine a scenario in which a mineral owner under the five wells in this New Mexico lease (shown below) concludes that at the end of year four it made sense to sell their well cash flow for three times the amount of money the lease produced in year four. After all, they’d put more than $3 million in their pocket (before taxes, of course).
Unfortunately, they’d fail to get the $10.2 million of cash that the well would generate until its abandonment.
The other side of the coin is a mineral owner whose ground has been drilled for the first time and who is unfamiliar with the concept of well depletion.
I saw this firsthand when I was travelling from a Utica conference in Columbus, Ohio, to visit with faculty in the University of Pittsburgh Department of Chemical and Petroleum Engineering. I was late leaving the conference and knew it would be too late to get dinner in Pittsburgh, so I stopped at the McDonald’s in Washington, Pennsylvania.
I walked in, and two guys—one young, one probably in his 60s—were seated and jawing at one another about the drafts they hadn’t yet cashed and bonus money they’d gotten for their Marcellus minerals. One was proud that he’d gotten an 18% royalty, the other was prouder that he’d gotten $200 per acre more, but they both moved on to talking about the businesses they were going to start and fund over the next five years—with a couple of new dually trucks and bass boats on the side. The way they talked about their upcoming cash flow made it clear to me that they figured their cash flow in month 40 would be like month three.
My first thought was that the best business bet in the area would be to slowly build a top-notch bankruptcy practice in the county to pick up the pieces when the wheels came off.
I’ve got friends with minerals that occasionally ask my opinion on leasing offers that they have gotten. In most cases, none of them have been familiar with what I would term “eliminating operator risk”—doing the best job you can to ensure the entity you lease to is good at what they do, and that they are actually going to drill your acreage rather than just offer you an extra $100 per acre, and then attempt to flip it and keep an override.
In the pre-unconventional world, drilling (and therefore production) was randomly distributed according to the formation of discrete (and acreage limited)
traps—fault blocks, salt domes, reefs, and angular unconformities.
This meant the number of mineral owners with producing royalties was limited.
The unconventional world in which we now live has greatly increased the number of producing royalty owners. The map below will give you a sense of how many new producing mineral estates have been created since the unconventional revolution began.
The blue dots represent wells that have been producing since Jan. 1, 2001, and the red and green dots represent wells completed in Texas prior to Dec. 31, 2000. The emergence of the Barnett play and the Eagle Ford unconventional play is clear.
The maps below show DI LandTrac Leases (gray) in the Permian Basin and Oklahoma that have instrument dates from the past five years. Leasing has been widespread and intense, adding new potential producing royalties to the universe of royalty owners.
Focusing on the Eagle Ford play, it’s easy to see that a huge amount of acreage got leased, implying a big increase in the number of first-time mineral owners who had their leases drilled.
Family trusts with long experience in administering and maximizing the value of their minerals will have advisers and staff to handle their mineral estate as a family business, but mineral owners new to the game usually won’t have these expert resources.
Potential lessors who consider a lease offer without knowing the leasing trends in their area, or who are willfully ignorant of drilling and completion activity in their neck of the woods, will NEVER maximize the value of their minerals.
Mineral owners—organize your mineral estate, get informed, and stay informed about what’s happening under and around your minerals, and make sure your heirs are brought into the administration of your mineral estate.
Doing so means that you and your heirs, working together, will have the opportunity to maximize the wealth of your mineral estate—the gift that keeps on giving.
Have a story you want to share about ensuring your heirs can administer their inheritance? Please send it to me at [email protected].
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