Generally speaking, is it better to buy an individuals mineral rights and corresponding royalty or purchase common stock of a basket of exploration and development companies?
In looking at unsolicited offers for certain minerals that I own, it seems that the offers now are approximately 3.5 to 4.5 times trailing 12 month cash flow (2016 offers). Now this production certainly is not in perpetuity but rather has a finite life at which time it will be plugged. This field may or may not ever be drilled again.
Conversely, I have been following a number of E & P Companies which at times have traded at around 10 times anticipated earnings, although now they are trading at well in excess of this due to depressed earning or even anticipated short term losses.
Between producing minerals and baskets of common stocks, which is the better investment and why?
I think it really depends on what kind of risk / return you want to make. E&P's that I researched and looked good 3 years ago, today are bankrupt. Other E&P's are more expensive (stock price) but have a long history of returns and will be successful in the future too. Minerals are more long term investments (in my opinion), because they are not as liquid as owning stocks. I think any strategy can be adapted to either minerals or stocks, because they can be applied in so many unique ways. If you want to spread out the risk, certainly buying minerals (finite, you can only buy so much) are limited to the areas you've purchased. E&P's may be more diversified geographically and in different parts of the business (upstream and midstream, for example). Another example of this is buying producing vs non-producing assets. Some people are probably more comfortable buying minerals than buying stock in companies that may come and go. Others are more in tune to stocks and follow wall street close enough to make educated decisions.
I appreciate the comments and analysis by both Kitchen and Hutchinson. For one I have never sold any minerals and likewise have never bought any minerals. Those that I have are ones that were passed down.
I have looked at acquiring minerals and I have certainly attempted to analyze the unsolicited offers that I receive at least monthly but often times with far more frequency.
It looks to me like purchasing minerals, whether some or all are actually producing, is a risky venture in that the majority of the parties willing to sell have a very small fractured interest and thus have no or very little control. One would certainly not want to pay on expectations that may or may not develop. So therefore, the purchaser is attempting to buy based on current production with upside potential in the event that the land is further developed.
Offers I have received in 2016, generally seem to be based on current annualize production at anywhere from 40 to 60 months. Looking back at offers from 2011 through 2014, the offers were far less but the monthly royalties were far higher. So what little analysis I have done, shows that unsolicited offers when oil is $37 per bbl are 3.5 to 5 years but when oil is $85 per bbl, the offers seem to be 18 to 24 months.
While these numbers seem to me to be low based on what I would not even consider, I don't think I would be willing to pay much more than that versus purchasing E & P companies where liquidity is immediately available and land holdings are very large and the companies, if managed well with low debt, will be around to fight another day.
What are participants hearing or transacting to purchase production when the royalty is small or highly fractured?
I agree with Hutch on this one. You would need to compare apples to apples. When investing in anything you need to know facts and not what a yahoo "finance experts" write that day to grab attention and get views. Where are the majority of the E&P companies assets? Different companies have plays in different basins. Research the basin to see for yourself if it is good or not. ( how many proven pay zones can be drilled unconventionally, if they have tested a density plot or not, if so did the laterals communicate and kill other new wells, if the E&P companies have the capital to protect their assets by holding them by production, what their hedges look like, ) If you believe in the Basin and have done your research then both are viable investments. Some companies have depressed values due solely from commodity price with great assets that aren't in danger, some companies have terrible balance sheets, with poorly structured foreign JVs that force them to still drill uneconomic wells due to their prior operating agreements in the JV structure, that jeopardize their assets.
Mineral buyers are just like any other investor, they like to make returns on their money, so they do research and some consult with engineers and structure buy lines based on their research. It takes a lot of time and research to invest in anything properly. Both in the stock market and minerals you should study the basins the assets are in, and who all else is active in the basins and what their results look like.
That being said, I regularly buy minerals and do not currently have money in any publicly traded E&P companies. The dollar is too strong right now and scares me away from assets that aren't considered a commodity (oil via mineral rights & gold/silver.
There are some fantastic deals that pop up from time to time. Here are a few examples.
You have information that an Operator is going to re-complete a well in a upper zone. The royalty owner has seen his royalty dwindle down to near nothing and has no idea that a bonanza is just a few months away.
You purchase royalty in horizontal units in Texas. For example, a new Operator is going to re-enter a well in Newton County. The well has not produced in years. The unit size in this one particular unit is around 1700 acres. One well will hold it, but in the future, when pricing perhaps improves, that one well turns into 8 wells. So the opportunity is when a well is declining and plans are laid to densify units.
I rarely buy minerals for my own account, but when I do, I have tight information.
The best way to buy production is with other people's money. At least, with my totally risk adverse view of life, it is. Find a good deal, sell it so that you have little or no sunk funds.
Best
Buddy Cotten