How to Diversify Your Mineral Portfolio
Don't put all your eggs in one basket
NOTE: OIL AND GAS INVESTMENTS ARE EXTREMELY RISKY. THIS INFORMATION IS NOT INTENDED TO BE INVESTMENT ADVICE – CONTACT YOUR INVESTMENT ADVISOR FOR PROFESSIONAL ADVICE.
Why Diversify?
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?
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.
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?
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.
Geological Diversification
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.
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.
Very Operators
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.
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.
Non-Producing Minerals
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.
Producing Minerals
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 an ORRI and the operator plugs the well and releases the least to cut you out.
The bottom line is that you need to consider your risk portfolio when buying producing and non-producing minerals.
Non-Producing Minerals
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.
Producing Minerals
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 an ORRI and the operator plugs the well and releases the least to cut you out.
The bottom line is that you need to consider your risk portfolio when buying producing and non-producing minerals.
Vertical vs Horizontal Wells
Horizontal (often fracked) wells are very expensive to drill but product 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, typically 5-12 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. W
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 verticle wells will produce much smaller checks but for a longer period of time.
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. W
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 verticle wells will produce much smaller checks but for a longer period of time.