The recent correction in oil prices has reduced acreage costs. Similar to how the real estate correction brought down valuations on high-quality buildings, the recent drop in commodity prices has significantly reduced purchase prices of properties as active drill rigs plummeted reducing demand for acreage. Now may be an opportunity for investors to acquire quality properties at significantly reduced prices.
The United States is one of the few countries where individuals and private entities can own the royalty and mineral rights; in most other countries they are owned by the government. As most of the rights are in the hands of individual landowners, when the property owner wants to explore for oil and gas on their land they enter into a lease with an oil and gas company, such as Exxon.
This mutually beneficial arrangement, grants the oil and gas company the right to explore for any resources on the land, while providing the technical expertise and capital.
The landowner benefits as he shares in the revenues from the producing well through the royalty, without having to provide the capital and technical know-how to develop and maintain the wells.
Source: “Some Simple Rules for Investing in Oil and Gas Private Placements.” Oil and Gas Financial Journal. Stephen Burr. September 1, 2010.
Similar to how REIT investors earn income from rent-rolls and benefit from any increase in overall real estate values, royalty investors earn income “rents” from the oil and gas companies in the form of a pre-negotiated royalty rate.
The royalty rate, which typically average anywhere from 12.5% – 25% of gross revenues, provides the property owner with monthly-cash flow (which we distribute quarterly) based on production volumes and commodity prices. This is passive income and the investor is not responsible for funding the drilling or maintenance of the wells.
Additionally, the royalty investor will participate in any increase in commodity prices through higher-monthly checks and, potentially, an overall increase in the value of the portfolio and underlying acreage.