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Joe Dumesnil - Minerals and Royalties - How to Make a Business Out of Knowing Where to Buy - Mailbox Money - NMA, NRA, ORRIs, Even NOWIs

Moneymakers Business Forum | 2019 Oklahoma City

Moneymakers Business Forum | 2019 Oklahoma City


Minerals and Royalties – How to Make a Business Out of Knowing Where to Buy – Mailbox Money – NMA, NRA, ORRIs, Even NOWIs. A Moneymaker Forum talk given by Joe Dumesnil, Overland Oil & Gas in Oklahoma City, Oklahoma on 4 April, 2019.

There are nuances to transacting in minerals and royalties and in many ways the business in these non-cost bearing asset classes is still very much a regional business, even opportunistically “grey” relative to other asset classes like equities and real estate. Mineral and royalties can serve as a physical hedge to reduce risk or compliment other business models, like working interests or positions in paper commodities. They can also serve as standalone business venture in a full or part time capacity. The deal size spans a large spectrum from hundreds to millions of dollars. The uncertainty of value spans an equally large spectrum from proverbial “goat pasture” to proven, producing and actively being drilled acreage. Once under ownership they do not incur any of the costs associated with drilling or completing a well(s), they only bear a proportionate tax and midstream deduction from revenue. There are skills sets beyond the geosciences that benefit a play in minerals and royalties making for a new skill to challenge oneself with or an opportunity for collaboration with other disciplines. Given a geoscientist’s skew to understanding regional and sub-regional nuance to mother nature there is natural fit for them to seek to understand this financial aspect at the surface of their below ground expertise. This talk will delve into these and more aspects of the mineral and royalties sector and the associated business models that can work in the space.

Full Transcript

Thank you, everyone. Thank you to the organizers for inviting me to present. We're kind of in the homestretch, here. We saved the best for last. There's a couple of presentations after me. I'm definitely not the best. It's going to be ramping up to the best. We're setting the bar really low for this presentation, OK? And Rick, unfortunately-- parent-child relationships. My daughter was not able to make it. She's a 3 and 1/2 year old. She was excited about the plane and the hotel that was going to be involved with this trip, but in her absence, we are going to talk about her college fund in light of mailbox money.

Overland Oil and Gas based in Denver. We consider ourselves an asset manager. We manage many different asset classes, be it royalties, minerals, non-operated working interest-- we may even consider drill coves over the past couple of years, but we do not operate. Whoops.

So just a quick over-line of what I'm going to try and run through in a short amount time. We'll do a quick poll. We'll do some definitions on kind of the value chain. I'm going to cruise through that. I want to look at some of the deal diversity that we've considered over the past couple of years-- some analogs and some of the nuance associated with those analogs that make minerals and royalties different than some of the analogs. We'll also look at the value. How do you value these things, either on a time, value of money perspective, or in the market? And then some strategies and suggestions and other nuances that I've noticed over the past couple of years. Oh, I did it again.

So who currently owns minerals in the room? If you can you just raise your hand? OK. Handful of folks. Maybe 10-20. Has anybody ever negotiated a lease as a geologist-- actually negotiated a lease? And then who's bought a home? OK, yeah, yeah, yeah. Figured. And who's picked stocks-- actually actively picked stocks-- in their portfolio? OK.

And anybody know what a DCF is? A discounted cash flow? Anybody done those? Some geologists have not. So PV-- present value, IRR. And then non-geos? This is a geology conference or a geology meeting. Are there non-geos in the room? Folks who just really do not identify with geos? OK. Cool. I'm sorry. Thanks for coming.

Well, just from a definitional perspective, I noticed they didn't tell me this till after about a year of hanging out with the Overland guys, that there was a difference between a net mineral acre and a net royalty acre. It's a fairly fundamental difference. And so I include this in there just for clarity's sake, especially in light of-- most things are not leased-- at least the things that we buy-- are not leased today at a typical landowner's royalty of 12 and 1/2 of 1/8th, 12.5%. Particularly down in Permian, we see things that are all the way in the 25% leased rate. We leased things last week in the Bakken at 22%. And when you're calculating a value of a future royalty stream based on what it's going to participate in, you've got to be acutely aware of that, because you may value one acre at one royalty rate completely different than another acre at another royalty rate.

With regard to overriding royalty interest, we consider those as well. And they're distinctly different. They're somewhat subordinate to a mineral acre from an asset class perspective. It's actually carved out, typically by the operator-- a lot of times, by the prospecting geologist. After they buy it from the prospector, they'll carve them out an override, and that comes out of the working interest portion of revenue, not necessarily the royalty interest revenue.

That said, there's also an equivalent type of asset class on the royalty interest revenue side. You can call it NPRI, or non-producing royalty interest, but that would be carved out by the mineral owner-- not necessarily the operator-- and that would typically not have voting rights, and wouldn't benefit from a lease bonus, or anything. It's just a percentage that the royalty owner might assign to whoever it could be. It could be his plumber. It could be his sibling. It could be anyone.

Frequently, we see a term aspect to an NPRI, so you need to be acutely aware of that-- whether or not the term might expire on the NPRI. We also consider non-operated working interest or NOWI is the four-letter acronym for it. Points-- point is a terminology that equates to 1% royalty. How much are you willing to pay for 1% of royalty? So a typical 1/8th royalty is actually 12 and 1/2 points. And then pooling and unitization. I identify pooling more with individual tracks that are pulled into a well, versus unitization, which is going to be more DSU spacing and how many wells are participating in a particular unit.

And just for clarity's sake, I want to show-- this is 100% spectrum on the top here in these two bars. Do you see that? Yeah. That's 100%. What we're talking about, really, is the red portion there. Frequently, the royalty interest owner will take on some portion of the gathering transportation and compression costs, their proportionate amount of taxes. But one of the things that's interesting when you start looking at this-- if we assume, let's say, a $60 barrel oil price and 1/6th royalty-- 16.767% royalty on a single well that's on a 1280 acre spacing-- let's say that's Bakken. Bakken's nice and uniform. They Space all the wells to 1280. They don't have discrete spacing for each individual well. We look at the royalty order share for a single barrel, and it's actually $7.97 of every single barrel.

That said, when we look at taking that up to their share of the well, assuming a 400,000-barrel well, they're talking about maybe $3,186 associated with royalty income from-- is that right? Yeah, yeah, yeah. I lost myself. My apologies.

And what we see here is just a multiplying effect. You see a single well, let's say $3,000 for the royalty portion of that well. We multiply that times actually 12 wells in the unit. Now you're at 38-- oh, it's million, sorry, I was thinking 3,000-- $3 million. you multiply it times 12 wells. You get up to $38 million in royalty income for the royalty owner, assuming, this is again assuming that they own 1,280 acres, the entire royalty stream for the unit. And that backs into a per acre price for that revenue stream of roughly $29,000 per acre.

So, a fairly sizable amount on a per acre basis. And we've actually transacted on a couple. We've sold some things in the Bakken recently at that roughly $25-$30,000 per acre mark. With regard to the deal spectrum, we consider things really that we would call three different tranches, really-- marketed deals, unmarketed deals, kind of off-market deals, and then auction sites. We participate in auction sites as well.

From the big perspective of marketed deals, we've looked at things up to 74,000 net mineral acres. It's a shotgun blast throughout the producing areas of the United States and the non-producing area goat pastures of the United States. The original ask we sized up to about 150 million. And in the end, we heard it transacted for roughly 75 million, about half that.

It was already producing also 500,000 per month. So that's the PDP component. From a smaller perspective, we looked at something just up in the Bakken with 6,000 net royalty acres. It went to market at 80 million. And we heard it transacted for less than 20 million. And it was all in one basin.

Un-marketed deals, another fairly large, wide spectrum. Saw something in the past year, it was roughly 2,000 net mineral acres, marketed at 45. Eventual sales price, we think was somewhere around 17. That's said, we've also looked at things that were half net royalty acre and it was marketed at 25. Eventually transacted for 15. And it had 25 DUCs just waiting to go into production.

From an auction site perspective, you end up with a much larger, again, a wide spectrum, but a little bit lower on the overall size. We saw recently 100 net mineral acres in Williston. Cash flowing already roughly $600 a month. What's interesting about the auction sites, and you have to watch these things acutely, is that they may be on the auction block for, let's say, in an open bidding process for, let's say, seven days. And the first six and a half days, the price won't even budge. And then in the last couple of hours, you'll see it just go, dida, dida, dida, and climb on up. In this case, we saw something transact greater than 22,000 an acre, and that all happened in the last six hours. It can be fairly exciting if you're that kind of junky. But it can also be kind of scary, as you go into that trying to win it. You got to be careful. Don't go too high too early, because you may need to save some of that powder for later. That was acreage that was already permitted and the rig was nearby. It wasn't necessarily goat pasture. That said, we've seen some smaller packages. And you regularly see smaller packages on auction sites, down to roughly 10 acres, 40 bucks a month. This is the greater Green River gas PDP Wyoming deal. And it really only transacted for 3,500 an acre.

Overland-- like I said, Overland's really on asset manager. That said, we are heavily weighted in minerals and royalties. The things that we do beyond there are really kind of secondary to the modus operandi for our committed capital. We have two funds. Currently, approaching 100% deployment on our second fund. And with that, we've been able to buy roughly 12,000 net royalty acres throughout the DJ and the Bakken. We do own some things in the Uinta. We own some things in Marcellus Uinta. We've done some Permian deals. And we actually-- we stepped out and started looking at deals beyond our backyard we were most familiar with. One of the things I'll note is that this is a great market. And it helps to go into there cautiously. Because really, in the gray market aspect of things-- actually, I'll get to that in just a second. Let me go ahead and--

The other thing to note on this slide is the permitting, the DUCs, and the sum of total wells that we calculate to be on the acreage, essentially you're trying to calculate what is the future cash flow of the potential that this gets drilled out in its entirety. We aren't necessarily just buying PDP. We're buying looking for upside typically. So we go ahead and forecast how many wells we think are going to be there. And the intrinsic value today is really focused on that, but heavily weighted to is it permanent, are the DUCs waiting to go on line for production.

When we look at analogs, the reason I asked about the houses is that it's definitely an analog market. I mean, that's one way to make money with money. You buy a house on the premise that it's going to appreciate. The efficiency in the market, it takes roughly four weeks to close on your house, and yeah, you can look at comps in all the neighborhoods around you and see what the comp price per square foot should be. Stocks, even more efficient. You get quotes on the seconds, quotes up to the second. You can close deals in seconds.

And both of those are regulated formally, including savings account, just another really passive way of making money with money. Typically the appreciation rate's or the interest rate's published. Minerals are different though. It's very much a gray market. The efficiency really depends. I've seen folks write checks on the spot for minerals. I've seen folks take three months to a complicated deal that had hair on it. The transparency is limited. It is occasionally regulated, particularly when you're working with-- well, it's regulated when you're working with investment banks that are dealing with marketed packages. But otherwise, it's not necessarily. It's up to you to regulate how the legal aspects of it, with regard to the deeds, and the transaction, and the assets.

And then, kind of uniquely, minerals, I think, we've got to notice this, is that they appreciate all the way up to the point that they depreciate. I mean, we're buying a depreciating asset, an eventual depreciating asset. So what you notice is that really in spots one through-- let's say spot one, it's a basin for inheritance that came to the current owner.

And then maybe it's leased it 1,000 an acre. And eventually, someone comes in, and the development in the basin comes in. Then it gets permitted. Then it gets-- the permit gets extended and the timeline gets drawn out further, eventually gets drilled. But then it goes online for production. And that production cash flow stream is going to depreciate with time. And so when you enter and when you purchase the asset, it's very important to be acutely aware of where you are in that appreciation and depreciation curve.

That said, I think PDP, we've heard already, frequently gets valued as a multiple of monthly cash flow, less so of PV. PUD, an even higher discount rate. That's what created a lot of the bid ask separation that yielded very few deals over the past couple of years. When things are permitted, it helps. If they're leased, that helps. We've definitely bought open acreage before. Frequently, it's open acreage and surrounded by other leased acreage.

But unleased, who knows. And why do we not know? Because there's so much uncertainty associated with the duration risk and the time that you'll actually begin initiating cash flow from that and revenue from that asset. And that duration risk is something you have to be acutely-- I would suggest need to be acutely aware of with regard to spending that money. Every money has a ticker on it and an expectation for that money to yield a return. And if you're not acutely aware of that going in, you're bound to end up, at least economically, under where your expectations were.

And with regard to the markets, I will say the markets are definitely gray. Before doing our first deal in the Permian, we looked at nine months of deals in the Permian, probably in excess of $100 million worth of deals, eventually resulting in us closing a slightly less than $10 million deal, just so we were familiar with that market. It wasn't our backyard.

So with regard to strategies, I think it's important to pick your strategy. You got to know who you are and stay in your lane. The slide to the right is actually some takeaways from a presentation I did at ICE this fall, this last year for AAPG in Salt Lake City. But are you looking for dividend paying mailbox money, like the residual dividend income? Or are you looking to play that appreciation curve and buy low and sell high at the peak before you actually start realizing?

One of the things you'll get is you'll get ordinary tax income on the mailbox money. And contrary to that, you'll get a capital gain on the appreciation if you buy at one basis and sell it before it actually goes into income. That can be a key differentiator as how you want to spend your money. It can't be looked at as a potential hedge to a paper position, given that it's fiscal. This is essentially the ultimate physical hedge.

Eventually, this oil and gas should have some sort of value. And so you can hedge against a paper position. And also, operators are frequently-- sometimes we're exiting to operators, because they just want to improve their NRI. So they're looking at a cost benefit of, well, should I continue to work at this NRI, or can I buy out my NRI? That said, if you're looking to source these deals, I might suggest checking in with some of the energy advisors out there. All you have to do is search energy advisors. Here's a list of a couple of them.

You can also start participating on Energy Net or PLS. They have tons of deals. I mean, shoot, 2,300 properties on Energy Net right now. Or you can start originating your own title and getting out there. One of things that's interesting about originating your own title is a lot of this stuff is post Louisiana Purchase type land grant stuff, that's filtered through the generations. And if you just consider that every couple had two kids, and you keep passing that on through the generations, you end up with roughly 256 independent, discrete tracks nine generations into it today and each two and a half acres apiece.

Granted, it's not that easy, but there's plenty of opportunities out there to transact in minerals in the Western-- west of the Mississippi. Assuming that, I would say that it helps to have access to database and production-- databases of production for analogs for doing your type curves. Excel, DrillNomics, PHDWin, Aries. Also your landman is your best friend. They're frequently the better negotiator than you. Lease and title analysts tend to know who and what you're actually buying from and what the lease terms are.

The division owner will help you determine actually what you're going to get paid on and how much you get paid. And the deal attorney's necessary. They remove all the hair and allow for the transaction to go through, so you actually own something after paying for it. And we frequently participate out deals and have many partners, because it's better to split the deal and take half rather than go lone wolf and not have anything to fight another day. Service lease agreements can be a lot of nuance. I think I'm short on time, so I'm going to go ahead and kind of wrap it up.

1031 exchange is a unique component to this, because it is a real property interest. And you can exchange real estate for minerals without paying tax. And I'm going to leave it right there for now so we can move on to the next one. Thank you very much.

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