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What’s all the fuss about buying and selling mineral rights?

By Austin Eudaly Published: July 31, 2014 8:47 AM
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If you are a land owner in Eastern Ohio or West Virginia that owns mineral rights under your land, chances are you have received letters from companies inquiring about purchasing your mineral rights. The letters vary, but the pitch is generally the same, i.e., sell your mineral rights for cash in hand today. Many owners, allured by the promise of easy money, may jump at this chance to profit, but may not always understand what it even means to sell their mineral rights or how to accurately assess a potential deal. 

The concept of selling mineral and royalty rights can be confusing. As with any business transaction, there are pros and cons to selling. This article is intended to shed light on the process of selling your mineral rights and how the implications of doing so can affect you and your family.  In an effort to try and clarify how selling mineral rights plays out in real life, let’s look at the following scenario. 

An Ohio land owner, (we will call him Mr. John Smith) owns 200 acres of land with the mineral rights in Guernsey County, Oxford Township, Ohio. Two years ago, Mr. Smith signed an oil and gas lease with XYZ Oil Company, giving them the right to drill on his 200 acres for 5 years with a 5-year option to extend the primary term. Mr. Smith was paid a cash bonus of $300 per acre and negotiated a 15% royalty on the lease. Now, two years have passed and no drilling has occurred.

What are Mr. Smith’s options? 

Mr. Smith has been receiving letters in the mail from a number of companies, soliciting him to sell his oil and gas mineral rights to them. He is unsure about whether he should, but the idea of taking cash in hand today has a certain amount of appeal. Below are two possible scenarios outlining Mr. Smith’s options at this point.

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  • Option 1:  Mr. Smith has the option to wait and hope for XYZ Oil to permit and drill a well. If the well is successful, Mr. Smith would benefit from his share of the 15% royalty in relation to how many acres he has in the drilling unit. Typically a drilling unit will be 640 acres. These payments would be in the form of royalty checks and would continue for as long as the well produced.  These checks can supplement what Mr. Smith does for a living and provide security for him and his family. 

In this scenario though, there are a few things Mr. Smith does not have control over. First, Mr. Smith cannot control the timing or occurrence of the drilling. Technically, XYZ Oil has 8 more years remaining on the lease he signed. For XYZ, the timing of drilling is effected by current commodity prices vs. the cost of drilling a well, existing pipeline infrastructure, drilling capital available and shale drilling expertise, to name a few.

Next, Mr. Smith cannot predict whether the drilling on his property will result in a productive or a non-productive well.  Geological rock properties, thickness of rock, faulting and organic content all play a part in determining an area’s potential. The geology can vary from township to township, and even section by section.  

In light of this, Mr. Smith begins to explore the idea of taking cash in hand today, as opposed to waiting and banking on things outside of his control.  Mr. Smith wonders how he would go about making that transaction, and most of all, if that is a prudent business decision. 

  • Option 2: Mr. Smith has the option of selling a portion, or all of his mineral rights, in order to eliminate his level of risk over issues he cannot control. He recognizes that by its very nature, the oil and gas industry holds a high degree of uncertainty and after weighing all the risks and rewards, he may choose what feels like to him is the surest option.
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What are the pros and cons to selling? 

The pro under the selling scenario is that he reduces his risk of XYZ Oil drilling a poor well on his property, or not drilling at all. He also reduces the risk of the oil and gas industry slowing down in the future or a significant drop in commodity prices. Mr. Smith may put some of this money towards his children’s or grandchildren’s college education or buy the retirement property he always envisioned. 

The potential downside to cashing out is that if XYZ Oil does drill a prolific well on his property in the years to come, he may have been able to get more money in the long run by holding onto all of his minerals. How much money depends on several factors: future commodity prices and the overall quality of the well’s production play a major role. Additionally, royalty income is taxed as regular income, so the future income tax rates that Washington sets will have a big effect on how much take home Mr. Smith will receive through the years.

So, Mr. Smith is now left with three possible choices—a) he can retain all of his mineral rights and wait to see what becomes of the outcome, b) he can decide to hedge his bet, and sell a portion of his mineral rights, or c) he can take the offer to sell all of his mineral rights and reap the full cash benefit.

What factors should be considered in this decision?

Mr. Smith’s financial situation, general life stage and risk tolerance all can play a part into which option he might choose. If Mr. Smith is 35 years old, has few financial needs and has a high tolerance for risk, he may choose to retain 100% of his mineral rights and wait it out to see what happens with drilling.

If Mr. Smith is middle aged, with financial obligations, and does not like the idea of the risk associated in waiting for drilling to occur, he may consider selling a portion of his minerals. By doing this, he receives a significant profit, but also retains a portion of his rights in order to “keep some skin in the game”. 

Lastly, if Mr. Smith is over the age of 70 and has no interest in waiting around to see what will happen with future drilling and commodity prices, or feels uncertainty in the fluctuating market, he may consider selling all of his mineral rights. 

In the end, Mr. Smith is wise to weigh his options carefully based on his own personal situation, leading him to the best decision for him and his family, which can give him peace of mind at the end of the day. 

Why are mineral acquisition companies out buying in the area? 

As of August 1, 2013, around 95% of properties in the Eastern Ohio or northern West Virginia region are either subject to an oil and gas lease signed in the past few years or are held by production (HBP) from an older oil and gas well. 

A mineral acquisition company may decide to pool money together to enter into an area like the Utica Shale or Marcellus Shale, to risk their money to purchase non-producing oil and gas mineral rights in hopes that one day drilling will occur and they might see a return on their investment. Generally, a mineral acquisition company will want to buy multiple mineral tracts across a trend, in order to “spread out” its risk, knowing that in the end it will spend money on both winners and losers. 

An acquisition group may also choose to purchase already producing mineral interests, as this can be less risky than buying non-producing mineral rights. Typically, to purchase producing minerals, a company will pay a lump sum payout to the landowner, based on the current monthly royalty checks received. 

Who are the mineral acquisition companies?

There are several groups in the Utica Shale and Marcellus Shale actively looking to buy. These groups fall into two categories: 1) mineral brokerage companies, referred to here as, “brokers”; and 2) mineral acquisition companies, also known as “end buyers.” 

The broker’s goal is to obtain an agreement with a mineral owner at a pre-determined price, in hopes of selling that agreement for a profit. For mineral owners that wish to sell, a good broker can be a valuable connection to an end buyer group that otherwise could not have been made. On the flip side, there are brokers who make impressive promises, but may not in the end, be able to deliver. These brokers can drive mineral rights prices up in an area, but may not actually have the cash to close a deal.  

Next, there are the mineral acquisition companies that are “end buyers”. These are groups with the cash available to close on mineral transactions. They may have several millions of dollars raised specifically for the acquisition of mineral rights in a certain area. Each company may have a different target area where they wish to spend their money. 

How does the actual selling process work? 

If a mineral owner decides to sell his or her mineral rights, the following steps describe the typical process for that transaction to occur. 

First, the land owner and mineral acquisition company would negotiate a price. This price is usually calculated on a price per “net mineral acre” that is being sold. For example, a land owner that has 200 acres and sells an undivided  50% of his mineral rights would be selling 100 “net mineral acres”. The owner would then retain the other 50% of their minerals.

A company’s cash offer can vary depending on several factors, which include the royalty percentage on the lease, term of lease, operator, proximity to successful wells, proximity to existing pipelines and the estimated ultimate recovery (EUR) of a well. For example, a tract that is held by production (HBP) from a shallow well with a 12.5% royalty that is far from pipelines would not be as valuable as a tract with a newer lease and 20% royalty that has a successful well producing a mile down the road. In some areas, a company may not have any interest at all in purchasing mineral rights if the property is too far away from the hub of activity or is inaccessible, due to pipeline constraints.

After evaluating these factors, a mineral acquisition company will extend a cash offer to a land owner and if accepted, a purchase and sale agreement will be signed to move the deal forward.

A Purchase and Sale Agreement (PSA) contract will state the price being paid per net mineral acre and the amount of time that the mineral buying company has to complete its due diligence. Usually, the time frame ranges between 4-8 weeks.

On larger transactions, a mineral owner may want to ask for up front “earnest money”, or a down payment that is non-refundable to enter into the agreement. This insures the land owner that the mineral acquisition company means business. Once title has been verified and approved by the buyer, the parties will move to a closing. 

At closing, the mineral owner will sign an Oil & Gas Mineral Deed in exchange for a check or bank wire. This process is best taken care of at a reputable bank in front of an Ohio public notary. The Mineral Deed will then be filed at the courthouse and ownership changed over. An oil and gas mineral rights sale will not affect the water rights, coal rights, gravel rights, pipeline rights or the surface use to a property. 

Are their tax advantages to selling mineral rights?

There are a few tax advantages to selling mineral rights that land owners may not be aware of that are worth discussing:

  1. Tax Savings: Taking advantage of the long term capital gains tax. As long as a land owner has owned their land for over a year, the sale of mineral rights is taxed as a long term capital gain; whereas, lease bonuses and royalty payments are taxed at the individual’s regular income tax rate.
  2. Paying no taxes at all: “10-31 Like Kind Exchanges.” When a mineral owner sells mineral rights, the transaction is classified as a sale of real estate. Under today’s tax laws, the proceeds from this sale can qualify to be used in what is called, a “10-31 like kind exchange.” 

Here is how that works, using our earlier example. Let’s say Mr. Smith sells 50% of his 200 mineral acres (or 100 net mineral acres) for a substantial amount of cash. Rather than pay the capital gain tax on the money from the sale, Mr. Smith is able to “roll the money” into the purchase of another piece of “like kind” real estate. Mr. Smith is not taxed anything at the end of the year on the money he made from the mineral sale, since it was used to purchase additional real estate. 

Mr. Smith could, for instance, take all of the money from the sale to purchase a retirement home in Florida and therefore, does not pay any tax from the money he made from the sale of his mineral rights. A 10-31 like kind exchange can be a complicated concept to understand, but the tax advantages to this scenario can be considerable. In matters such as these, it is always important to consult a professional tax advisor or financial consultant to help understand the do’s and don’ts of the process. 

One of the nation’s leading 10-31 like kind exchange experts, Tracey Wilson, is Vice President of the Investment Property Exchange Service Inc. (IPX 10-31) that has a local office in Columbus, Ohio. Mr. Wilson had the following to say about selling oil and gas mineral rights and the implications of completing a 10-31 exchange, “When anyone sells real property – real estate, oil & gas, water rights, mineral rights, etc. – they may have a profit, or a capital gain. And today’s (2013) capital gains tax rates are significantly higher than they were last year. The only way to defer those capital gains taxes is to ‘roll the gain over’ into some other real estate – and they must do so using Section 10-31 of the Internal Revenue Code, and they must have a Qualified Intermediary to complete the process.” Mr. Wilson and his company are the nation’s largest Qualified Intermediary and complete several hundred 10-31 like kind exchanges each year.

Can I hear from actual Ohio residents that have recently sold mineral rights or decided not to sell mineral rights to hear their feedback?

David Taylor, a native of Belmont County, who owns 80 acres of land that is held by production (HBP) from a shallow well, recently sold 100% of his mineral rights. When asked why he had decided to sell, Mr. Taylor said “I have bought several sugar plums, having dealt with different oil companies. My current lease paid me $5 per acre and 12.5% royalty (the minimum allowed by law). My producing well paid me less than $200 in 2012 … this has made me less than happy. An offer was made to buy all of my oil and gas rights. After waiting seven years for that ‘big money,’, it was time to re-evaluate my situation. Being 78 years of age, I would rather have money in my hand than in the bush.” 

When asked about the company he dealt with, and if he would recommend them, Mr. Taylor said “Several companies had contacted me, most with a very nice proposal that might pay me in 90-120 days, or longer, at their choice. Flatiron Energy Partners offered a reasonable price and paid very promptly. No other offer was made to compare at all.” 

Mrs. J. Fisher of Carroll County owns 35 acres of mineral rights and recently decided to hold on to her minerals when she received an offer to sell. When asked why she decided to sit tight, Mrs. Fisher said “Carroll County is currently the hot spot for drilling. There is a rig drilling 2 miles down the road from me, so I feel I will get drilled in the next year or two. I know there’s oil down there.”

Robert “Bobby” Shugert owns property in Guernsey County, Belmont County, Harrison County and Washington County, all in Ohio. Mr. Shugert sees the tax benefits in the 10-31 “like kind exchange” scenario . Mr. Shugert said, “We look at the tax savings and financial security of selling oil and gas mineral rights now and doing a 10-31 exchange, versus the potential of when, or if acreage will be included in a drilling unit. If you end up getting drilled, the total estimated recovery and future tax rate on your royalties are two factors that are currently unknown that will determine if selling mineral rights now is prudent.”  

Jim Yoder of Belmont County, Ohio also recently decided to sell his 73 acres of mineral rights. When asked why, he said, “I am Amish and a main concern for me is the amount of truck traffic that is going to occur in the coming years if the Utica Shale drilling comes in. The roads may not be safe and all the racket will not be good. I plan on using the money from the sale of my minerals to buy a farm in an area that will not be so loud and crowded with trucks.”

Without a doubt, it is an exciting time to live in Eastern Ohio or West Virginia where the Utica Shale and Marcellus Shale have the promise to infuse life and pump money into the local economies. Hopefully, this article has helped you better understand what it means to sell mineral rights and has helped you think through whether this is an option worth your consideration. In the end, there really should be no fuss about it; instead, only a reasoned, informed decision that works best for you.

Austin Eudaly is the VP of Acquisitions for the mineral rights acquisition company, Flatiron Energy Partners, LLC (Flatiron). Flatiron is based in Dallas, TX and has an office locally in St. Clairsville, OH, at 47443 National Road, Suite 2, St. Clairsville, OH 43950 located at Exit 215 & I-70 next to the “Big Green Barn”. Flatiron is actively purchasing oil and gas mineral rights in the Utica Shale and Marcellus Shale areas with a primary focus in: Guernsey County, Noble County, Washington County, Belmont County, Monroe County, Harrison County and Carroll County, OH, Marshall County, Wetzel County, Tyler County, Ritchie County, Doddridge County and Harrison County, WV and Washington County, Greene County, PA. Mr. Eudaly can be reached at Flatiron’s Ohio office at (740) 449-2164, or cell (817) 683-4777 or email Austin.Eudaly@gmail.com, Flatiron website: www.flatironenergypartners.com.

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eselby Jun 23, 2015 10:46 PM

We own minerals in Colorado, but the basics apply here as well.  After reading this, I take exception to the assumptions made.  My wife and I are in our 70s.  By your assumptions we should be selling our minerals as we are old and risk-averse.  We own the minerals in a family trust and they are currently producing a small income.  More drilling is planned in the drilling block.  Sure, we won't likely see much more income from this property in our lifetimes, but that doesn't mean that I want to sell it off to someone who is amalgamating blocks of producing minerals.  We don't need the money - more would be nice, but we don't "need" it.  I see it as a long-term asset which will benefit my children, grandchildren, and?  It upsets me a little that you imply I should just sell it because I am old.  That implies a "me" attitufe, at the potential expense of my downstream family.

ljmaldonado Apr 27, 2014 5:57 PM

I am interested in a RE property advertised for sale,well at least I was until I read the fine print.  The owner states he will retain mineral, gas and oil rights and royalities. How does that work if I would be purchasing the property? Confused in Ohio, Plz help. Is this legal and how can u sell ur property and house and expect to keep anything pertaining to house or the land?

MarkisGenius Mar 16, 2014 7:41 PM

great article! Will definitely recommend this to my friends and family who wants to know more about mineral rights. Just like Mr. Smith I actually have a neighbor who sold their minerals through DML Energy, a small firm that works in PA and OH.. I think they are a Denver company but my neighbor was paid in 45 days, and was happy with their offer.