The following information was written for Michigan farm owners, but with the expanding domestic search for oil, gas and minerals, there is good advice for any horse farm owners. This article is from Michigan State Universityand was written by Curtis Talley Jr.
Landowners and mineral owners in Michigan are receiving offers to sell rather than lease their mineral rights. There are many things to consider for both the short term and long term when evaluating the sale of mineral rights.
For landowners who own mineral rights (mineral property), consideration of the value of minerals is generally an afterthought, particularly if there is no current mineral income. For those fortunate enough to live in an area of valuable mineral deposits, they have learned that mineral income can exceed the income from the surface if it is managed as a business enterprise.
Recently, mineral owners in parts of Michigan have been receiving offers to purchase rather than lease non-producing mineral property. These offers come in areas where oil and gas development is also beginning to occur. This article does not discuss valuation of producing mineral rights.
Defining Mineral Property
The Michigan DEQ brochure on mineral rights states that “mineral property can have several different forms. Mineral property includes hydrocarbons (oil, gas and coal); hard rock minerals (gold, silver, copper and other metals); and other types of minerals (talc, bentonite, uranium and others).” Mineral property can also include potassium and commercial gases and can vary from state to state.
Potential sellers may be assuming they are only selling the oil and gas rights (hydrocarbons), which could be a mistaken assumption. If the sale contract does not state only the oil and gas rights, it could include every type of mineral or gas that is considered a mineral and encompassed in the definition “all.”
Michigan State University Extension recommends these considerations when evaluating the sale of mineral rights. Some of these are listed below:
- Be cognizant of what “partnering together” might mean in a mineral purchase offer. It might mean the buyer plans to purchase an undividedinterest. When you split an 80-acre tract into two 40-acre tracts, you are dividing the property. When you sell an undivided interest, you are selling a portion of the whole. The offer might be to purchase a 50% undivided interest in all mineral rights for $125/acre. This means that entity would receive 50% of all mineral income from 100% of the acres, potentially for eternity. To go one step further, in the sales contract the seller may unwittingly be assigning the legal authority to negotiate all mineral leases to the buyer.
- In the next part of this article below, the sample well produced $450,000 in gross income (25 barrels/day x 200 days x $90/barrel = $450,000) in the first year. A .125 (1/8) royalty based on gross income produced $56,250 ($450,000 x .125 = $56,250) for the landowner from the 40 acre tract, or $1,506.25 per acre. This indicates that if the mineral owner is fortunate enough to eventually negotiate and receive royalties that income can be substantial.
- Splitting the mineral estate from the surface estate provides no incentive for the new mineral owner to consider future mineral extraction impacts to the surface owner. Oil and gas companies often prefer dealing with a mineral owner that is also the surface owner because it reduces the number of owners they are working with.
- When a surface owner sells the mineral ownership, any control over the siting of future roads, drilling sites, tank batteries and other related facilities is lost.
More Tips for Comparing Sale vs. Lease
As we continue the discussion of the short-term and long-term considerations in evaluating to purchase rather than lease non-producing mineral property, you need to understand the following:
- A sale is usually a “forever” transaction; once sold they are gone. A mineral lease can be long term if there is mineral production, or shorter if the acreage is not part of a drilling unit that produces royalties. Continual ownership may provide the opportunity to lease multiple times and receive multiple bonuses.
- An exception to “forever” is the Michigan Dormant Minerals Act. In this act, severed oil or gas rights revert to the surface owner after 20 years unless certain actions have occurred within the 20-year period since the deed was recorded. A mineral owner in Michigan should be aware of this law as it may provide an opportunity to reclaim the mineral rights if the buyer does not comply with this law.
- Who Can Sign an Oil and Gas Lease? states how the ownership deed is structured and determines who has the right to sign the sales contract. For example, if the land is held as joint tenants, all joint tenants must sign the contract. If one is unwilling to sign, no agreement can be consummated.
- Offers to purchase frequently tout the sale will “reduce” risk. It might reduce the risk of receiving no royalty income in the future, but what about the future sale of the surface without mineral rights? Will a sale of mineral rights affect future marketability of the surface? If mineral production, such as oil and gas wells, are present but the surface owner is not receiving royalties, the marketability of the surface may be negatively impacted. On the other hand, intact minerals with royalty income can be attractive to certain surface buyers, as it provides additional cash flow.
- The buyer is not obligated to continue ownership after a purchase is made. As with the oil and gas lease market, whatever is purchased can be re-sold to another buyer for potentially more than the purchase price.
- Outright sale vs. a lease bonus. Mineral purchase offers may advertise that a sale produces immediate cash income. The bonus (up-front cash payment) for signing an oil and gas lease also provides immediate income. Lease bonuses can range from $15 per acre to as much as $6,000 per acre, depending on location and lease demand.
- Income taxes. Purchase offers may advertise that the sale proceeds will be taxed as long-term capital gains ( 2013 tax rates are 0% to 20% depending on taxable income vs. 10% to 39.6% for earned income) if the property has been owned for at least one year. Taxation can be a little more complicated than that. Capital gains taxes are paid on the profit from the sale. For example, if you sell a share of Exxon for $150, bought it for $100 and owned it for more than one year, the long term gain is $50 (profit). You pay tax only on the $50. For a mineral rights sale, the calculated capital gain will be based on the basis assigned to the mineral rights when you purchased the land, which may be “0”. If the basis is “0”, the entire amount of the proceeds would be taxed as capital gain income.
- Technology in the mineral extraction industries is constantly changing and improving. Areas that were once thought to not have economic mineral development potential are now being developed. The owner of the mineral rights at the time of development is the one receiving their portion of the income.
Because of the complexities of a mineral rights sale, Michigan State University Extension recommends that a knowledgeable oil and gas attorney with experience working for private landowners be consulted to assist in understanding a sales contract. An oil and gas educational web page provides free educational materials including “Oil and Gas Expert Resources for Private Landowners,” which includes a list of attorneys that have stated they have a specialty in mineral rights. There are also other downloadable resources related to oil and gas leasing, mineral rights and links to related web pages.