How Mineral Rights & Interests Value is Determined?

Calculating mineral rights value properly is something that many investors struggle with. Discovering you have paid too high a price for mineral rights can be a costly mistake. You naturally may feel shafted. More likely, you were the victim of shoddy valuation methods. To stay away from such situations, it is crucial to know how to determine mineral rights value properly.

The value of mineral rights constantly changes with fluctuating commodity prices and mineral production levels. The booms and busts of the global mineral market make forecasting future mineral prices tricky.

With valuations further sabotaged by unforeseen black swan events (political coups, extreme weather events), mineral values are on a never-ending rollercoaster ride.

These mineral rights valuation risks (price risk, production risks, etc.) can be minimized when the correct mineral rights valuation methods are used.

This article explains how to value mineral rights using reliable valuation methods, assess the most critical factors in mineral rights valuation, and maximize your mineral rights value.

Why Value Mineral Rights?

Since sellers of mineral rights try to get the highest price. In contrast, buyers of mineral rights seek the lowest price, and both parties have a financial incentive to place a higher or lower value, respectively, on mineral interests.

All parties can ensure a fair market price for mineral rights and avoid costly misguided valuations by using a valuation method that is consistent with market practices and at arm’s length – that is, each party acts in their own self-interest in determining the value.

A misguided valuation will not only affect the sale price of mineral rights but also impact the economic viability of all aspects of mineral rights exploration and development, including these:

• Raising of public and private funds for mineral projects
• Securing of loans and other types of project finance
• Conducting merger and acquisition activity
• assessing of mineral rights taxes and insurance
• Managing operating expenses.

Types of Mineral Rights Valuation

A mineral owner selling mineral rights will not seek the same valuation as an insurance adjuster or even necessarily rely on the same valuation methods.

An inheritor of gold mineral rights on his grandfather’s property learned this expensive lesson.

When his neighbor’s insurance company valued the adjacent mineral rights at $1,500 per acre, he decided to hold onto his interests.

But a month later, another neighbor sold his mineral rights for $2,250 per acre just before gold prices declined.

This potential seller was blindsided by the market opportunity to sell his gold rights at a high price because he used the wrong valuation method as a market reference point.

The 4 main types of mineral rights value are:

1. Fair market value – Used in buying and selling and investing in mineral properties, fair market value is the value determined on the open market among parties doing business at arm’s length.
2. Book value – Book value is the worth of the mineral interests after the project has paid off all its debts (assets – liabilities). It is the liquidation value of a company in bankruptcy.
3. Insurance value – This is the appraised value by an insurance company, used to set the price of insurance as part of its risk assessment. Though an insurer may use the fair market value, they have an incentive to lower the valuation to reduce future insurance payouts.
4. Appraised value – An appraiser will focus on comparing the valuation of mineral rights with those of nearby properties. This valuation is different from that of a real estate appraiser valuing the land, which may or may not include surface and subsurface mineral rights.

How Mineral Rights Value is Determined?

The valuation of mineral rights takes into consideration production and potential production levels, the costs of production, and factors affecting the commodity market price.

Key mineral rights valuation parameters

We can say that there are 4 main parameters that you should be aware of:

1. Minerals type and quality – the type of mineral resource, quality of in situ-grade, depth below service (deeper reserve deposits will be more capital-intensive to mine).
2. Production levels and forecasts (used to determine the future cash flows of a project) – production yields, potential recoveries.
3. Cost of exploration and production – working cost assumptions (the cost per ounce provides a comparison of how much it costs to produce each ounce of a mineral), capital expenditure forecasts, rehabilitation costs (regulations in most mining regions require the miner to reserve rehabilitation liability funds to remediate environmental damage.)
4. Price forecast inputs – commodity prices, mineral price forecast, exchange rate, cash flow discount rate.

Many other factors affect the value of mineral rights.

Your rights will be worth more if the site uses new technologies that improve extraction efficiency (fracking/horizontal drilling) or if a low-cost electricity source or pipeline infrastructure is nearby.

In contrast, high environmental risk or potential for a seismic activity will reduce mineral interests’ value.

Who owns the land also matters. Private property owners may be more willing to negotiate for smaller mineral acreages. But if the government has some or all rights reserved, you will be subject to less flexible pricing and predetermined royalty rates.

The more detailed the mineral rights valuation, the more accurate it will be.

Discounted cash flow (DCF) method

The discounted cash flow method is the most thorough and common way of valuing mineral rights, as well as the companies that own the mineral rights.

DCF values an asset-based on estimates of the future cash flows it will generate. Estimating future cash flows requires a detailed forecast of the annual production and cash flows of the mine.

A discount rate is then applied to the total cash flow amount to determine the cash flows’ net present value.

The discount rate reflects various risks associated with mining rights. These include country, political, and environmental risks.

In a country where the government is unstable and mining laws inconsistent, mineral rights will have a higher risk factor than in the United States, a country with well-established mining rights laws and regulations.

Quick Mining Rights Valuation Methods

Sometimes a ballpark mining rights valuation is sufficient, and you can avoid the expense of hiring appraisal and engineering experts. The following methods are used in estate planning, taxation, and real estate sales (i.e., sale of land with mining rights).

Comparable transaction method (R/ha)

This method compares the values of properties with similar characteristics. General inputs include the mineral type and in-situ grade, surface depth, and proximity to the mining infrastructure.

3X cash flow method

As a mineral rights value rule of thumb, the 3X cash flow method is often used. To calculate mineral rights value, multiply the 12-month trailing cash flow by 3. For a property with royalty rights, a 5X multiple provides a more accurate valuation (stout.com).

US dollar per ounce method

The US dollar per ounce method estimates the in situ mineral reserves. The dollar per ounce is then determined based on recent mineral reserves rights sales transactions.

Producing vs. Non-Producing Mineral Rights

Producing Mineral Rights Value

Mineral rights are valued based on the present value of future cash flows, adjusted for risk. Once production starts, cash flows are known, and therefore many project risks are reduced.

1. Production rate – Actual production volumes are known and no longer estimates, and thus project cash flows more certain. For oil and gas reserves, the price risk post-production is higher. Since these liquid minerals flow among adjacent properties, the appraisers can apply an accurate flow rate once production starts.
2. Future production rate – Based on actual production, future production forecasts can be determined with more precision.

Non-Producing Mineral Rights Value

For non-producing assets, cash flows are uncertain, and production risks much higher. Risks associated with non-producing wells include:

• Future production rates are estimates.
• Price risk is very high as prices could fluctuate before production begins at a future date.
• The timing of production cannot be forecast with certainty. The developers could drill many dry wells before the asset is productive.

Mineral Rights Value Varies By Location

Many local government factors affect mineral rights valuation, and therefore it is not uncommon to see substantial differences in mineral rights valuation across U.S. states or countries.

Since federal and state governments often establish different royalty rates and mining rules, the valuation of mineral interests will differ.

Environmental policies, for example, increasingly influence oil and gas rights valuation. Maryland, New York, Vermont, and Washington have banned fracking, which currently accounts for about 60 percent of U.S. oil production (Wikipedia). The lower gas production in these states has raised gas prices – unlike oil, gas is a local market.

And rather than price, local production has a more significant impact on value.

Consider the soaring valuation of mineral rights in the Permian Basin – the U.S.’ largest oil reserve spanning west Texas and southeast New Mexico.

Since crude oil production started on its current upward trajectory in 2013, Permian Basin production potential has spiked.

The number of uncompleted wells has risen 452 percent to 3,612, but crude prices have fallen 84 percent to $57. Despite the price decline, both royalty rates and lease bids at auction are rising in Texas and New Mexico due to high production estimates.

In 2013, land prices per acre began to climb past $20,000, and, more recently, a few deals have surpassed $70,000.

The prolific Permian is affecting land prices across North America.

The increase in Permian Basin oil and gas prices in recent years have pushed up the price for land per acre not only in the region but across the United States.

In Canada, the Permian has had the opposite effect; because oil sands projects have been less economical than horizontally drilled Permian projects, the value of mineral rights has declined.

How Does Subsurface Area Affect Mineral Rights Value?

Mineral property rights comprising a larger subsurface area are typically more economical to produce and thus more profitable.

More efficient horizontal drilling technology, for example, requires larger areas of adjacent wells to benefit from economies of scale than vertical drilling.

Among the benefits is the ability to use the same equipment and infrastructure onsite. Prepare to do more due diligence on larger land areas.

Leases on mineral rights, government rights reserved, and potential environmental liabilities must be considered on each tract.

While more attractive leasing terms could be negotiated, keep in mind that horizontal drilling lease terms sometimes dilute royalty interests.

How Much Are My Oil and Gas Mineral Rights Worth?

Oil and gas as leasable minerals – mineral rights leased to the owner who, in turn, receives royalty payments – are valued differently from sedentary minerals.

The following factors are used in the valuation of oil and gas mineral reserves rights:

• Current level of production and production on adjoining lands.
• Lease term and production revenue.
• Decline curve on future production estimates (rate of production decrease).
• The number of wells drilled and an estimate of future wells and depth.
• Active and expired permits.
• Royalty revenues generated.
• Discount rate (reflecting the risks).

How royalty rates affect oil and gas rights value?

Royalty interests pay out a percentage of the production or revenue of an oil and natural gas lease.

The number of royalties paid out by mineral owners declines as the reserves decline.

This royalty can be sold, gifted, or transferred, thereby transferring the mineral rights associated with the property. If a royalty interest is sold, the buyer needs to know the percent of the interest in the oil and natural gas lease.

As royalty rates paid to the public (federal and state governments) and private mineral rights owners increase, they significantly impact mineral rights value.

For sedimentary minerals (gold, uranium, copper, platinum, etc.), a royalty of 3–5 percent is common among many developed mineral markets worldwide.

Federal governments have imposed a 12.5 percent oil and gas royalty rate on mineral rights on federal lands since the 1920s. But both US federal and state governments are taking higher cuts in regions where mineral rights value is soaring.

In the states spanning the Permian Basin, royalty rates are 25 percent (Texas) and 18.75 percent (New Mexico).

More factors to consider:

1. Production on adjacent land – Because oil and gas are fluid resources that can flow across adjacent properties, the “rule of capture” applies. If the neighboring properties have many active wells in production, this could reduce the estimates of potential producible reserves on your property.
2. Seismic activity – Both hydraulic fracturing and wastewater disposal from oil and gas operations have been linked to an increase in seismic events. University of Miami researchers have identified over 600 seismic events related to fracking in U.S. states.
3. Shale thickness – The cost of drilling through thicker shale increases capital expenses when using fracking and horizontal drilling technology.

How to Maximize Mineral Rights Value When Selling?

Mineral owners can increase the value of mineral rights by timing sales for when:

• Wells or mines are currently in production,

• Permits have been issued for new production and/or

• A mining or energy company currently leases the mineral rights.

The value will also increase if the area has high hydrocarbon accumulations.

Mineral Rights Value – 4 Common Mistakes

1. Failing to compare discount rates – The key inputs of asset valuation – be it a gold mine, company, or home – involve a degree of subjectivity in their determination. Two uranium mines on adjacent properties with similar features could have considerably different valuations. In your assessment, you should compare the discount rates used to derive the final value. A higher discount rate connotes higher mineral rights risks and will produce a lower cash flow estimate.
2. Over relying on historical data – Commodity prices are volatile and prone to experience large swings and black swan events. Past prices and production history offer a benchmark for price forecasts. The most accurate gauge of market value is the lowest price sellers and the highest price buyers are willing to transact in the current market.
3. Miscalculating royalty interest on horizontal drilling and fracturing – Unlike vertical drilling, horizontal drilling pools lease parcels to form one production unit. Royalty interest may also be allocated differently. A 10 percent royalty may not be paid on the production of all tracts comprising a production unit but instead, be based on a pro-rata share of the royalty interest. An anti-dilution clause will specify whether the entire unit or a percentage is considered under the lease (hh-law.com8).
4. Confusing net mineral interest and net royalty interest – Net mineral acreage is the percentage of the total acreage covered by a lease owned by the lessor. This figure is multiplied by 8 to derive the net royalty interest. For more details check our article on the different types of mineral interests.

Conclusion

If you are ready to list or purchase mineral rights, the best mineral rights value rule of thumb to use is the current market price. Today, your mineral rights may sell for $2,000 an acre, but if the developers drill a few dry wells tomorrow, that value could plummet.

Caveat emptor, especially in a market prone to unfair pricing and scams. For both buyers and mineral owners, detailed knowledge of the value of mineral rights is market power.

You may consult some popular mineral rights websites, but they offer only a rough estimate of what your mineral rights could sell for.

Here at Pheasant Energy, we specialize in helping mineral owners and entrepreneurs trade their minerals for a value that will satisfy both their needs and the person or organization on the other side of the contract.

When considering the many factors (discussed above) that affect mineral rights valuation, the cost of a professional, fair market value appraisal could save you millions of dollars in the future.

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