Think of your minerals as an island in the Caribbean. Your island neighbor might own property just one mile away from yours, and they received an offer for $1 million and you received an offer of $500,000 from the same group. Shouldn’t you demand the same price?
Below is an in-depth analysis of many factors which affect the price of your mineral estate, but we would encourage you to pick up the phone and give us a call - a conversation is always more meaningful than an infomercial.
But my neighbor was offered 3 times more!
In 2018, Hefner Energy began acquiring minerals and royalties in an area of Grady County which would later become known as ‘Project Springboard’ - a 9 mile x 9 mile area where Continental Resources announced they would drill 350 new horizontal wells. Averaging $7.5 million per well, this would amount to more than a $3 billion investment into a relatively small area of Grady County. We have deployed nearly $30 million into this area during that time frame making Hefner Energy the largest acquirer of Project Springboard mineral and royalty assets in country (absent Continental Resources themselves).
When we began in January 2018, we were purchasing for $18,500/acre (well above all our competitors at the time who were paying about $10-12,000/acre). However, once Continental announced Project Springboard, prices soared past $18,500/acre. Why? Timing and number of wells per unit. An investment that used to be valued as a Bucket 3 was basically now valued as Bucket 2 (i.e. it was worth significantly more, as we will expand upon below).
However, we found mineral owners OUTSIDE of Project Springboard in Section 20, Township 6 North, Range 6 West, Grady County (just outside by one mile) demanded the same prices as their neighbors INSIDE Project Springboard in Section 17, Township 6 North, Range 6 West where Continental Resources had paid $41,250/acre. They simply did not understand why their acreage was not worth more than we had offered them (and they still are not worth it today).
Inside Project Springboard we are able to, as investors, take the timing risk largely out of the investment. Continental had told us when they were going to drill AND how many wells they were going to drill per unit (spacing risk). This dramatically inflates the value of the minerals inside Project Springboard. Unfortunately for owners outside of Project Springboard, even just one mile removed, we do not, as investors, know when (if ever) additional wells will be drilled nor do we know how many will be drilled (if they are at all).
So, just because your neighbor who owns in the adjacent section to you receives an offer for three times that of what you are being offered has nearly nothing to do with the value of your mineral estate.
Discounted Cash Flows (Timing risk)
We categorize your minerals into one of five buckets to risk each acquisition based upon timing (investors do this in many ways, but this is how we do it at Hefner Energy);
Bucket 1: where the first well is drilled (to hold the acreage by production and avoid losing leases) and the density wells have been drilled (all the wells which will be drilled to the formation).
Bucket 2: where the first well is producing (exactly like that of Bucket 1) but, unlike Bucket 1, the density wells are about to be drilled, or are currently being drilled, and the investor gains access to the “flush production” (the first 6 months of production, or more).
Bucket 3: where the first well is producing (exactly like that of Buckets 1 and 2) but, unlike Buckets 1 and 2, we do not know when the operator plans to drill the density wells. It could be the following month, in seven years, or never.
Bucket 4: where first well is about to be drilled (or is in the process of being drilled), and density development timing is unknown.
Bucket 5: where we are completely uncertain whether a single horizontal well will be drilled, much less density wells.
“Showboat Density” Pilot Project
Blaine County, OK
In 2018, Devon Energy announced they would be drilling the “Showboat” density to test 25 wells between two Drilling & Spacing Units (“DSUs”). The west unit, shown here, is actually known as the ‘Mosasaurus’, and Devon Energy drilled a total of 13 wells in this 640-acre DSU.
Hefner Energy paid $40,500 per acre to buy into this unit. Unfortunately, we significantly overpaid for this asset (which will be discussed later on in this article).
This property is an example of a Bucket 1 investment if it were made today (although at the time of investment for Hefner, it was Bucket 2).
So, why do these buckets matter to you?
They matter because it determines the value of YOUR minerals. The illustrative chart below shows you the relative value of your minerals as they are classified in each of the aforementioned buckets.
Why would a Bucket 2 be worth more than a Bucket 1, or a Bucket 3 less than a Bucket 4, investment you might ask? This is due to the fact flush production (the first 6 months of production, or more) having already been paid out to the mineral owner (i.e. an investor is not going to capture those cash flows, and from the now partially-depleted wells). So, your peak value of minerals will come when they become (if they become) categorized as a Bucket 2 investment.
Unfortunately, very few properties ever make it to the revered Bucket 2 classification. There are 71,068 sections in the entire state of Oklahoma and only 4,164 sections have 3 or more horizontal wells drilled on them (just 5.8%). The vast majority of Oklahoma is classified as Bucket 5 (and it’s highly unlikely that will ever change).
Well Results have significantly Changed Values for the worse
Finally, (a) well results are not always great and (b) companies lay down rigs. Let’s go to the “STACK” for this discussion.
In 2018, Devon Energy (a leading developer of the STACK) was suggesting they were going to run 10 rigs and drill 14 wells per unit. So, most companies were willing to underwrite 14 wells per unit and, given the number of rigs running, push their timelines for density development forward (increasing the value of discounted cash flows and, thus, the value of the associated mineral estate). Companies like Teton Range were paying $25,000 per acre across the board in entire townships - the STACK was on fire!
Fast forward to today (Sep 2019). Devon Energy is running ZERO rigs (in the entire state of Oklahoma) and Teton Range is no longer buying minerals (in fact, they have only made one acquisition in 2019 out of 250 total acquisitions since 2017). What happened and how did it all change so quickly?!
Well, Devon drilled 13 wells in a unit (referenced above as the “Showboat Density” which Hefner Energy invested in for far too much - $40,500/acre) to test their development theory of what the Meramec formation was capable of. The parent well (i.e. the first well drilled) produced 148,796 barrels of oil and 1.248 billion cubic feet of gas in its first 12 months online (2016). When the density wells finally came online, they averaged 50,028 barrels and 0.237 billion cubic feet of gas in their first 12 months online (just 25% of what the parent well produced in the same time). This was a major miscalculation and, today, Devon Energy has not only revised their density development plans in the STACK from 14 wells per unit to 4-6 wells per unit, they have also laid down every single rig in the state of Oklahoma. Mineral and royalty values have taken a massive hit as a result of these well results.
Mineral values significantly decreased in the ‘stack‘
So, if you were fortunate enough to have sold in mid-2018 you were paid FAR more than your minerals were ever worth ($25,000/acre to $40,500 per acre in some cases). Today, those same minerals are trading for $5,000 - 15,000/acre. In fact, the average dollar per acre slid from more than $25,000 per acre back in March 2018 to now just $3,750 per acre in August 2019 (shown below).
In short, minerals do not always increase in value (as is the case of minerals in the ‘STACK’). Also, your property is valued very differently from that of your adjacent neighbors (as is the case just one mile removed from Continental’s Project Springboard).
We hope you have found this helpful, and that you consider Hefner Energy should you ever become curious about selling your minerals.
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