Appraiser’s & Mineral Rights
From United States v. Tishman Realty and Constr. Co.
“The fact . . . that a valuation reached has in it baffling elements of speculation and surmise does not mean that it should not be employed. One guess may be better than another guess, since not all guesses have in them the same element of intelligence. The realization that a considerable amount of conjecture is involved should not paralyze the function of deciding, but it should induce humility. Dogmatism is clearly out of order in a modern valuation case.”
Dogmatic valuations of mineral rights are not to be expected. Rapidly changing prices for oil and gas makes those valuations a moving target and change occurs much more rapidly than the overlying surface rights.
The mineral right is the domain of the person expert in this area. Designations such as MAI are not indicative of expertise, rather it requires training and expertise. The average Certified Residential appraiser should not attempt to include mineral value in their reports nor be bullied into doing so.
The 1004 form has only a check list for “Fee Simple” or “Leasehold”. You must add a statement to explain your intention to exclude the mineral right from the valuation and what impact that has on the surface value. (In most residential cases the impacts are zero.)
Other Impacts
Secondary markets explicitly require the appraiser to address the presence of operating wells, pipelines and other such items if encountered during the inspection. It is good practice to learn what these items look like, and how to address each in the report.
You can usually find the location of wells, including old wells on the state oil and gas regulatory commission. In Oklahoma, this is called the Corporation Commission. Texas calls it the Railroad Commission. Most other states will call it the Oil and Gas Commission or something similar. Often they have GIS sites you can search your area for the location of wells nearby.
What is given away?
Since non-producing minerals are rarely taxed, they do not go to the tax sale and they do not expire except in Louisiana which requires dormant minerals to revert back to the surface owner after 25 years. A mineral right deed may give only the rights to certain minerals. It could be limited to oil or gas, coal, or hard minerals only. The government even kept mineral rights in much of the old Homestead land, especially that homesteaded after the 1920s when the US was concerned about a shortage of oil after the Great War. In the early 1950s when uranium was the key strategic mineral, those lands were explicitly reserving uranium ores to the government.
Implicit in a mineral right is the right of egress-ingress. The mineral owner has the right to “enjoy” their mineral and thus can come on the property of the surface owner and explore for oil but must pay any damages.
Sometimes a contract for sale may exclude the mineral rights but does not get recorded until the contract is fulfilled. In one recent contract I viewed, the seller reserved the mineral rights only during her lifetime. Another quirky method is the Royalty deed. A person may give away the royalty income from the producing wells on the property but not the mineral right itself. They are to be avoided and impossible to value except by the income stream. Think of them as a “life estate” in the income from the wells.
Petroleum Companies lease land to drill and are leasing the mineral rights, not the surface. They pay damages to surface owners. That surface owner may or may not be the owner of the mineral. Normally they avoid drilling near buildings or homes with set back provisions in leases usually from 200′ to 400′. Colorado recently require a 2,000′ setback which has caused some 70-80% of the state private lands to be “off limits.” This will dramatically reduce drilling in that state.
BLM land is leased to oil companies. Many people have purchased land in the Rockies thinking they own the fee simple only to find that they have a drilling rig nearby and that they personally do not own any minerals and have no control over that rig. The state also lacks jurisdiction for the most part when drilling is done on public lands.
How Do I Determine the Ownership?
The appraiser should check the deeds in oil country and add the question to your homeowner questionnaire. “Do you own the mineral Rights?” “Are they leased or held by production?” “Do you get a royalty check?”
Title companies should have a reference to mineral rights but very old mineral rights were often neglected and do not show up on deeds. Over-conveyance is another problem. Badly worded conveyance of mineral rights could end up appearing to give up more than 100% of the mineral.
Lease Terms
▪Term
▸The length of time the lease is good for
▪Bonus Payment
▸Up-front money tendered at the signing of a lease
▪Delay Rental
▸If drilling does not commence in the first year, a delay rental payment is made. Usually a few dollars per year
▪Royalty
▸Royalty is the percentage of the proceeds that the mineral owner will be paid out of any production. Gas is paid in money from the gross sale of the gas, whereas oil is given to the mineral owner as a share of the oil, but it is usually marketed by the oil company unless the mineral owner desires to sell his oil independent of the Petroleum company
BOE – Barrels of Oil Equivalent
MCFGE – Thousand Cu. Ft. Gas Equivalent
Approximately 8 times the energy is in a barrel of oil as in a 1,000 CF (MCF) of gas. When gas is $8 then oil should be $64/bbl. Due to the glut of gas associated with drilling horizontal “liquids rich” wells, natural gas is very cheap and that ratio is approximately 20:1.
It is Beyond my Expertise
That is applicable to the average appraiser. Few of us have the expertise to value mineral rights. It is a specialists job. Therefore, the appraiser should caveat away the issue with something similar to this:
Disclaimers You Can Use
Rights Appraised
The property appraised is the fee in surface. This is fee simple less the mineral rights. The subject may or
may not have mineral rights intact.
The subject property is the fee simple less the mineral right. The appraiser has not included a mineral
right in the valuation.
The subject property has intact mineral rights and is the fee simple title. There is no market evidence that
the mineral rights will affect the property value significantly. Mineral development, specifically oil and gas drilling, does not currently impact values within the subject sphere of market influences.
The subject property interest is that stated on the deed. The deed explicitly does not include the mineral
rights. See the copy of the deed in the addendum.
Disclaimer of mineral interest
A title opinion was unavailable. The appraiser could not determine if the property has an intact mineral
estate during the normal course of business. There is no market evidence in the area that lack of mineral rights will impact the value of the subject land and improvements at its highest and best use as residential property.
Mineral leased
The subject has an oil and gas lease in effect. The subject has no existing [gas, oil] wells or related
development. As is, the property values are not impacted by nearby drilling. A general increase in economic
activity has occurred which is a positive factor for local land prices, but an individual property might be impacted in the future. It is beyond the scope of the appraiser’s ability to predict that future unknown impact.
The subject is appraised “as is” and does not include an estimate of the contributory value of the mineral
right. Therefore, the rights appraised are that of the fee simple less the mineral rights, or otherwise known as the fee in surface.
The subject is appraised “as is” and does include an estimate of the contributory value of the mineral right.
That value is included in the estimate of the land value in the cost approach. The comparables reflect property sales where the mineral interest sold intact and therefore, require no adjustment. Therefore, the rights appraised are that of the fee simple.
Mineral producing
The appraisal includes all rights of the Fee Simple, including the mineral interest. The appraiser has
informed the client that they are not competent to value a producing mineral interest. The client has decided…
1 …to exclude the mineral right from consideration. I have examined the impact that development has had
on the subject and concluded that the surface and improvements are [not] affected. I have made an appropriate adjustment to the property to account for the loss in value from the on-going oil and gas drilling. I have allocated that loss to external obsolescence in the cost approach.
2 … to include the mineral right value. The appraiser has informed the client that they lack the competency
to develop a value for a producing property. The client has agreed to pay for a mineral valuation to assist the
appraiser. The appraiser has engaged the services of a professional and have no reason to believe the value
provided by the professional estimator is not reliable. The oil and gas professional has assisted the appraiser in developing the value of that interest.
Valuation Methods
Minerals without Production
Deeded Sales
In Arkansas and Oklahoma, mineral deeds must affix deed stamps to the deed. In Arkansas the rate is $3.30 per $1000 of transaction value. In Oklahoma it is $1.50 per $1000. If the deed is explicit enough to tell you how many acres is in the tract, then you can calculate the per acre (net mineral acre) value. Also, many counties in both states actually require a separate statement that gives the exact transaction price, which may be down to the nearest penny and not rounded to the nearest $500.
Courthouses may keep mineral deeds in the Oil & Gas book separate from regular deeds and where leases are also recorded. Ask the clerk for assistance. Oklahoma records are on line for the most part.
Not many other states require deed stamps on mineral rights, and sales must be identified and the individuals contacted or a source of information obtained (sometimes auctioneers have sales information on mineral sales.)
Multipliers
The traditional landman method of value mineral rights is to multiply the current going rate for leases to a multiple, usually 3. In “hot” areas, that multiple might be 5. Low prices means low multiples. Old wells with low production also bring low multiples. If a lease is in effect, then the multiplier may also depend upon how much the royalty is. A 1/8th royalty might be a multiple of 4 where a 3/16th might be 4 and a 20% royalty might command a multiple of 5.
Local lease prices can be discovered by asking people recently leased or when oil companies petition the Oil & Gas Commission for a drilling permit under unitization (force-pooling), they must state what they will offer anyone being force-pooled. This varies from area to area.
Producing Property
Multipliers
If a property has an income history, then an offer may relate to the past production history. An offer might state they will give you the same amount of money that you have earn in the past 36 months or 48 months. This “months to payout” relates to the total amount already earned. If prices are rising, then this method favors the buyer but if prices are falling, it might favor the seller.
Reserves Based Methods
An engineer or trained professional can calculate the remaining reserves in the ground (under a unit that is in production.) This usually requires at least two or three years production history. These “decline curves” can then be vetted by a trained engineer or appraiser to estimate the amount of reserves remains.
The valuer then “risks” – applies a factor for risk – these reserve estimates and multiplies the owners interest (division of interest) to estimate the net reserves that the owner has. From that the owner can apply one of several methods.
In Ground Unit Pricing
Companies sell reserves in the ground. This is commonly considered to be around one-third the current market price. This can be estimated from sales by companies which are reported in trade papers or reported on the SEC’s “Edgar” system for public companies. It is a disclosure requirement.
Discounted Cash Flow, Hoskold’s Premise, etc.
Several methods of estimating cash flow and discounting that cash flow for the time-value of money and for risk can be applied. The most common one is Discounted cash flow which estimates the income from the reserves and the anticipated timing of the production from the wells.
All methods are estimates only and actual income can only be determined by actual production and the variability of the market prices which vary with supply and demand and economic conditions.