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Fair Market Value Appraisal of Unleased Minerals and Leased Minerals Even if They Are Not Developed and Generating Royalties.  September 1, 2017

Minerals are often leased, but do not get developed immediately.  When this happens, the mineral owner has received a one-time bonus payment in the form of dollars per acre at the time of leasing.  That payment is normally the only payment that is received until the minerals are developed and royalties begin to flow to the mineral owner.  If the minerals remain undeveloped, the next payment that will be received is a new bonus payment for renewing the lease term or leasing to a new party.

 

Occasionally we receive calls asking for guidance on the sale of leased mineral rights.  Mineral owners want to consider the option of simply selling the mineral rights for a larger lump sum of cash today rather than receive smaller bonus payments when the lease comes up for renewal and continue dealing with the uncertainty if the minerals will ever be developed.

 

It is common for mineral owners to receive numerous offers in the mail to purchase mineral rights.  Mineral owners collect these letters and let them stack up, not sure if the offer price for the mineral rights is fair.  Determining a fair price is often not easy for the mineral owner because the minerals are undeveloped and not generating cash flow.  Therefore seeking professional guidance is beneficial even though the mineral owner will have to pay a consulting fee.

 

It is very important for the mineral owner to perform some due diligence before accepting an offer from mineral buyers.  Mineral buyers are trying to accumulate a sizable mineral interest by getting people to sell smaller interests that are not producing cash.  Mineral rights buyers do this through the incentive of lump-sum cash payments to mineral owners today.  This can be enticing, particularly if the mineral owner needs the money.  The offers from mineral buyers can virtually always be negotiated upward.  With some research and generation an economic model using defensible assumptions, we can often justify increasing the offer you have received.

 

If you are a mineral owner and the minerals are undeveloped, there are two typical scenarios:

 

1.       The minerals are not leased and not generating income, so therefore there has been no bonus payment and there is no royalty being paid to the mineral owner.

 

2.       The minerals are leased, but have not been developed, so therefore there has been a bonus payment but no royalty being paid to the mineral owner.

 

Scenario 1 requires review of the location of the minerals relative to the nearest production of economic mineral development whether that is oil, gas, sand and gravel, aggregates, or any other mineral.  The nearness of minerals that have been developed will be the best comparable to generate some data and find an appropriate price per acre that an independent Investor would pay.

 

If there is no mineral development nearby, the value of the minerals still must be evaluated as an independent Investor would see the opportunity.  With no mineral production nearby, an Investor would move to the next best data available which would be exploration data and estimates of minerals in place and their potential economic value.  Since these minerals are not economically proved, one would expect a significant discount to be applied to a cash flow forecast.

 

Scenario 2 considers the lease that has been signed for the minerals.  The lease will have a dollars-per-net mineral acre lease bonus figure, the lease term in years, and other information such as royalty in the event that the minerals are developed.  The lease bonus is the lease market value of the minerals on the day the lease is signed.  There is also sometimes an annual rent which is a minimum annual payment that is stipulated in the lease to be paid in order to keep the lease in force until such time as production is established.  The value of that cash flow stream would approximate the amount of money an investor would pay to purchase the minerals in fee.  To arrive at fair market value, one would project the future payments of the lease bonus and apply an appropriate and defensible discount rate to the future payments assuming there is a growth rate.  Alternately, one could capitalize the future stream of lease bonus payments.

 

If production is nearby and the minerals are leased, one would conduct research on the drilling and permitting for new wells or other mineral development in the area.  Pooling and unitization should also be checked to see if the minerals will be included in a larger spacing unit than simply the spacing that would be applied to the well alone.  If future development is in the foreseeable future and there are development plans, the future cash flows of these minerals can be considered as revenue because that is how an investor would also evaluate the property.

These materials have been prepared solely for educational purposes to contribute to the understanding of oil and gas appraisal. These materials reflect only general concepts in the industry based on Colorado and may not apply to all circumstances.  It is understood that each case is fact ‐ specific, and that the appropriate solution in any case will vary.   These materials may not be relevant or apply to any particular situation.  While every attempt was made to ensure that these materials are accurate, errors or omissions may be contained therein, for which any liability is disclaimed.