Are you thinking of investing in mineral rights? If so, you should be aware of some common pitfalls to avoid them and get the most out of your investment.
Investing in oil and gas can be very lucrative, but it can also be risky. You should be aware of pitfalls to avoid falling victim to mineral rights scams.
While this is not a guide on buying mineral rights, this article aims to inform and prepare you to avoid the most common mineral rights mistakes. Note that this article is only for educational purposes, and you shouldn’t take it as investment advice.
Let’s get started!
Key takeaways:
- You must work with a trusted advisor and do intensive due diligence to avoid making mistakes with your investments.
- Mineral resources are finite. Knowing the lifecycle stage in which the minerals are currently in is important to make an informed purchase decision.
- Investing in new wells in risky because royalties from the first months of production can’t be consider3ed constant. It is a declining asset, which usually stabilizes or levels out after the first year.
6 Common Pitfalls of Investing in Mineral Rights
1. Not Doing Enough Due Diligence
When it comes to investing, doing due diligence is the first and most crucial step you should take, and investing in mineral rights is no exception.
This may come as no surprise to you, but more often than not, mineral rights investors don’t really know what they’re investing in. And poor or no due diligence may result in your purchasing mineral rights from someone who doesn’t actually own the rights. You may also find out later that the person you’ve bought mineral rights from owns only a small fraction of what they thought they had owned.
Here’s the list of some of the most important factors to consider while doing your due diligence:
- Geology and engineering review
- Production analysis
- ROI analysis
- Lease and operator review
- Royalty statement analysis
- Title runs
- Lease terms review
With more than 35 years of experience, Eckard Enterprises analyzes, evaluates, and negotiates mineral rights for its account and Partners. This offers investors an opportunity to leverage the experience needed to overcome common pitfalls.
2. Investing in Non-Producing Minerals
Not doing proper due diligence may lead you to invest in non-producing mineral rights. Like the term implies, non-producing minerals are mineral rights in a tract of land with no active gas or oil well.
Of course, if there’s no active well, there’s no revenue, and ultimately, there are no royalties for you as well.
And you can’t expect the non-producing minerals to suddenly start producing after you invest. Minerals may stay non-producing for years, decades, or even generations, while some non-producing minerals will never get drilled. Other minerals may get drilled, but they may result in a dry hole or a well with only a short interest period, making your investment go to waste.
On the other hand, if you pick the right location, investing in non-producing mineral rights in active slate plays can bring you high returns.
3. Investing in Interest in New Wells
While you may think that new wells have a big potential, that’s not always the case. You shouldn’t use the royalties from the first months of production to determine the value of the property.
Generally speaking, a one-year-old well produces one-half or a third of its initial production. As a result, a valuation based on the first 6-12 months of production will result in dramatically overpaying for the interest.
Also, considering well production decline curves and analyzing the surrounding activity can provide additional insight into the production outcome of one or multiple wells located on a mineral tract.
4. Investing in Interest in Old Wells
Since minerals are finite resources, it’s not really a good idea to invest in old wells as well. Successful conventional wells typically produce smaller amounts of oil and gas in the long run. On the contrary, the newer horizontal wells produce large quantities of hydrocarbons, but only for a few years.
That’s exactly why buying interest in an old well is risky. It may be near the end of its resources. Once there are no more resources left, you no longer generate income from your mineral rights.
5. Investing in Working Interest
There are six types of mineral rights:
- Mineral Interest (MI)
- Royalty Interest (RI)
- Overriding royalty interest (ORRI)
- Working Interest (WI)
- Non-operated working interest
- Net profits interest
If you don’t understand these thoroughly and accidentally buy working interest, you’ll end up with the responsibility to operate the well and pay all the costs.
As a non-operated working interest owner, you won’t be involved in everyday operations, but you’ll still have to pay your share of the expenses.
For these exact reasons, a lot of mineral rights investors prefer to invest in mineral interest (MI), royal interest (RI), an overriding royalty interest (ORRI).
6. Accepting Unfavorable Lease Terms
Last but not least, many mineral rights investors don’t engage an expert advisor that can help them find mineral rights with a strong return. Your advisor can guide you so that you avoid these pitfalls and help you negotiate lease terms. This is one of the huge mistakes, usually leading investors to leave money on the table.
Experts know the pitfalls and ways to maximize your value. Here’s an example. A common lease term may provide the operator with free gas to run the well, which diminishes the yield. Many operators run their frac fleets on natural gas at your expense.
But that’s not all; investing in mineral rights with unfavorable lease terms may lead you to some major legal risks.
What Does This Mean For Your Money?
When you’re making an important investment, you want to get the most out of it and minimize risks. When investing in mineral rights, you need to work with people you can trust to avoid these common pitfalls.
Contact the professionals at Eckard Enterprises for expert guidance on finding and procuring mineral rights as part of your investment portfolio.
