Key Takeaways
Evaluating an offer for mineral rights begins with understanding the ownership interest, including acreage, royalty provisions, and the production and pricing factors that determine royalty income.
The value of mineral rights depends on anticipated future income from existing wells and potential drilling activity, accounting for production declines, commodity prices, timing, and risk.
Comparable transactions and market-based valuation measures can help assess an offer, but differences in well economics, development potential, and ownership characteristics make interest-specific analysis essential.
An offer to buy your mineral rights puts a dollar figure on something you may have owned for years. Whether that number is reasonable can be much harder to figure out.
Perhaps the royalty check is the part of ownership you know best. You recognize the operator’s name, notice when payments rise or fall, and have a general sense of what oil or gas prices are doing. But deciding whether to sell calls for a closer look. What does the interest include? What income might it produce in the future? And how does the offer account for those expectations?
Understanding the answers gives you a better basis for evaluating the price. The place to begin is with the interest itself.
Understand What You Own
At Mercer Capital, we frequently hear from mineral owners who know the name on their royalty check and the amount they receive, but little about the details behind it. That is an understandable place to start, particularly when interests have passed through a family and the original documents are difficult to locate.
A royalty statement can help fill in some of the blanks. It identifies information about your ownership share, the product being sold, and the location of production. Those details help explain what generates your income.
The ownership decimal may look like a minor detail, but it connects the revenue shown on the statement to your share. Consider the example in our post, How to Understand Your Mineral Interests: 80 net mineral acres within a 640-acre section, with a lease royalty of 3/16. Under that example’s assumptions, the calculation is:
80 ÷ 640 × 3/16 = 0.0234375, or 2.34375%.
That decimal represents the owner’s share of the production revenue in the example. The larger gross revenue figure on the statement belongs to the calculation; it is not the amount the owner receives. Understanding the acreage and royalty arrangement behind your decimal helps you make sense of the payment.
Lease documents provide further information about the arrangement and its economic terms. Although leases may look similar, their provisions can differ. Understanding those details helps establish what is being valued before you begin judging the price.
Look Beyond the Check Amount
Your latest payment is useful information. It is also only one part of the picture.
Royalty income depends on both the quantity produced and the price received. First, check what is being sold. In the statement examples in How to Understand Your Mineral Interests, gas appears as product code “204” on one and as “G” under the “P” column on another. The statement’s legend provides the translation. These are examples, rather than codes every operator uses.
Knowing whether the interest produces oil, natural gas, natural gas liquids, or a combination helps you connect the payment to the relevant commodity.
Why might the check fail to follow the price you see in the news? The price received depends partly on location and the infrastructure available to bring production to market. Pipeline constraints can cause local production to sell at a discount to a quoted benchmark. Meanwhile, the quantity produced also affects revenue. Tracking the headline price alone leaves those pieces out.
Before comparing an offer with your latest payment, look at the production and pricing behind that payment. They provide a better starting point than the check amount alone.
Consider the Income Still to Come
A valuation looks beyond income already received to what the interest may generate in the future.
For existing wells, that means examining production over the remaining useful life. Production generally declines over time, and historical production helps inform expectations about that decline. A recent payment cannot simply be assumed to continue unchanged.
What about wells that have not been drilled? The valuation process can consider income from planned or potential future wells, as well as existing production. Future drilling opportunities also matter when comparing the interest with market transactions. Where that potential is already reflected in the analysis, it should not be added again.
Future commodity prices enter the projections, too. Expected revenue reflects both production and price; taxes and applicable expenses and deductions affect the income remaining.
Timing and risk matter throughout. Income expected in the future must be translated into a value today, with consideration for the uncertainty involved. Appraisers often use a discounted cash flow analysis for this purpose. The terminology is technical; the underlying task is practical: estimate future income and assess what that income is worth now.
Understand the Limits of Comparisons
Looking at what similar interests have sold for is a sensible way to put an offer in context. Finding a useful comparison takes more work.
Direct transactions involving comparable royalty interests can provide meaningful evidence of value. However, the necessary information is not always available. When it is, the comparison requires attention to differences between the interests.
A nearby sale is a useful lead, but location alone does not establish comparability. The analysis must consider differences in well economics and potential future drilling locations. A transaction involving different production prospects may need adjustments before it provides a meaningful indication of your interest’s value.
When direct transaction information is limited, publicly traded royalty aggregators, trusts, and partnerships can provide additional market evidence. Their acquisitions and financial measures may help develop valuation comparisons. Those comparisons still need to account for the characteristics of the particular interest; a published figure does not automatically apply to yours.
For the same reason, a rule of thumb can give an owner misplaced confidence. Applying a standard multiple to royalty income may seem straightforward, but it can overlook the characteristics that make the interest more or less valuable.
Our discussion of the royalty valuation process explains how market evidence and expected income can be considered together. Each contributes information; the usefulness of that information depends on how well it fits the interest being valued.
Bring the Information Together
Evaluating an offer starts to become more manageable when the pieces are considered together: the rights and economic terms, the production behind the payments, the income expected ahead, and relevant evidence from the market.
A valuation brings those pieces into a supported conclusion. The calculations matter, but their credibility rests on the analysis of the particular interest. That is especially important when ownership records are incomplete or a familiar monthly payment has been the owner’s main source of information.
The goal is to understand enough about the interest’s value to put the offer in perspective. A price is easier to evaluate when you can see the economic factors behind it and the uncertainties that remain.
If you are considering a sale or would like a clearer understanding of your mineral or royalty interests, Mercer Capital can help you evaluate their value and the factors that drive it. Contact a member of our oil and gas team to discuss your situation in confidence.