How to Diversify Your
We buy oil and gas royalties and mineral rights in Kansas and throughout the United States.
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The ageless advice of not putting all your eggs in one basket applies to mineral acquisitions just as much as it applies to anything else.
Let’s say you have a fantastic well located in one of the major shale plays. It’s been so successful that you decide you’d like to own more, so you focus your efforts on getting more interest in the same well and those nearby.
But what happens when, three years in the future, there are so many prolific natural gas wells that the operators can’t find a market for the gas or the pipelines are full and the well must be shut-in until the operator can get the gas to market? Or, the wells have a particularly short lifespan and royalty checks dry up?
If instead, you had diversified your mineral portfolio by buying mineral rights in wells different geological formations and with different operators, all your eggs wouldn’t have been in one basket.
Investing in oil and gas is among the riskiest investments, but by diversifying the types of minerals you purchase, the location, and operators, and type of well (horizontal or vertical), you lower the overall risk.
Another way to diversify your mineral portfolio is to invest in interest that is operated by various companies. Let’s say you find a particularly good operator – they drill prolific wells and treat mineral owners fairly so you look for more mineral interest, royalty interest or overriding royalty interest , operated by the same company, expecting to share in their success and buy more interest.
What happens when the price of oil drops and the operator cannot secure financing to drill more wells or the cost of operating the well exceeds the revenue produced from the well? What if the operator is bought out by or merges with another company – one that is known to to be shady and suddenly your revenue drops?
It is best to look for mineral rights that are operated by a variety of companies. You might even consider prioritizing larger, more experienced operators who have the financing to weather market volatility. Or large independents who are likely to be acquired by the majors.
Producing and Non-Producing Minerals
The market for producing minerals (those generating revenue) is always higher than that of non-producing minerals, but there may be a place for both in your mineral portfolio.
Purchasing non-producing minerals is extremely risky because there is a very real possibility that a successful well will never be drilled in which case, you may never see a return on your investment. Or, it might turn out to be fantastic because you will have executive rights and be entitled to the least bonus, delay rental payments and royalty payments based on your decimal interest in the well or wells. It’s a gamble and very risky.
The sometimes safer but still very risky option is to buy producing minerals. Even then, it is extremely important to know what you’re doing. A lot of people think they know what they are doing, especially when first starting out, but in reality, they know just enough to be dangerous.
For example, you might purchase royalty interest in a brand new well based on the first few months of production but not realize that the decline curve will be steep and you’ve just paid more for the interest than that well could ever produce.
There are a hundred other ways in which you could lose your money – perhaps the price of oil will drop, maybe the operator will go out of business, maybe you purchased or inherited an overriding royalty interest and the operator plugs the well and releases the lease.
Explore 24 common risks associated with buying, owning, and selling mineral rights.
The bottom line is that you need to consider your risk portfolio when buying producing and non-producing minerals.
The most obvious way to diversify your mineral portfolio is to invest in properties in a variety of geographical locations, including various states and counties within the state.
By owning an interest in multiple shale plays, you reduce the risk when one play falls out of favor (such as what happened in 2019 when Colorado passed anti-drilling legislation), and increase your opportunities when new plays heat up.
Vertical vs Horizontal Wells
Horizontal (often fracked) wells are very expensive to drill but produce huge quantities of oil and gas. Their decline curves are extremely steep, producing a majority of the oil and gas in the first year or two. Horizontal wells have a short lifespan, sometimes only 5-15 years.
Conversely, vertical wells produce comparatively small quantities of oil and gas but typically have smaller decline curves, and in some cases, can produce for decades.
It is a good idea to own both vertical and horizontal wells. The horizontal wells will give you larger paychecks in the beginning, while the vertical wells will produce much smaller checks but for a longer period of time.
How We Value Mineral Rights
There are many factors that play into the value of mineral rights. These include location, producing vs. non-producing properties, current oil and gas prices, well production figures, lease terms, and even the operator of the well or wells. We also look at the risks of buying and owning minerals that you are interested in selling.
Minerals in the hottest shale plays are more valuable than those in older fields with conventional wells.
Producing vs. Non-Producing
Producing minerals are often worth more than non-producing minerals because they are generating revenue.
Oil & Gas Prices
When oil and gas prices drop, revenue drops, and sometimes operators are unable to continue operating the well.
Highly productive wells (and off-set wells) can increase the value of your minerals.
Favorable lease terms (such as a 25% royalty reservation) positively impact the value of the leased minerals.
A small number of operators are unethical, and their reputation automatically devalues your minerals.
Why People Sell Their Mineral Rights
I am putting my affairs in order. I don’t want to burden my kids with the hassle of transferring ownership and managing small mineral rights. When my sister passed away, my niece and nephew had to hire an attorney to help them with the minerals. I don’t want my kids to go through that.
I inherited my mineral rights so they were sentimental, but I don’t really want to bother with managing them and filing extra tax returns. I decided to sell and use the money as a down payment on my house.
I had no idea how fast the oil production would decline. My checks are only 20% of what they were a few years ago. I should have sold my mineral rights when the wells were brand new and still generating huge royalties.
My oil wells have been producing for decades and the reserves are almost depleted. Once the wells are plugged, the value will be significantly lower. I’d rather cash out now.
I inherited mineral rights, but don’t want to be involved with fracking and fossil fuels. I would prefer to support renewable energy and do my part to reverse climate change.