Hey all,
I am a mortgage banker and am here in hopes of getting some help.
My client receives Oil Royalties form their land within Eagle Ford. The underwriter has asked for independent verification that the income is 'stable' and 'expected to continue for the next three years'. An engineer report was recommended as one option, but expect that to be prohibitively expensive and time consuming.
I assume a huge amount of due diligence is done before a well is put up. Does anyone have a recommendation as to who would be able to chime in (from a professional perspective) to support the continuance of this income? Studies on the length of time that a standard well in this area produces? How about something that says "if a company installs "x" type of well, it generally means they intend to reap "y" amount of oil.
Any other thoughts?
Zachary Love,
WJ Bradley Mortgage Cpaital, LLC
San Diego, CA
http://www.theoildrum.com/node/9506
The piece found at the link above is about the Bakken rather than the Eagle Ford play. That said, it is worth reading. I have interests in four shale wells in the Bakken in Montana and counsel all of my relatives who share these interests to be conservative as re depending upon income from these wells, based upon the information provided in this piece. I hope it is disproved, but until it is, I expect rather rapidly declining returns from these wells. See what you think.
Zachary,
Since none of us can see into the ground, nor predict the effects of mechanical application to unknown geologic attributes of a formation, the "due diligence of putting a well up" is limited to the confidence of management in the geologists and engineers making the recommendations. Consequently, the best projections of well income are best left to geologist and engineers measuring what has happened then with experience and the assistance of mineral economics, project forward. Hiring competent professionals is both expensive and time consuming.
Borrowing money on anticipated production payments from oil and gas that is non-operated is a pretty quick way to foreclosure without independently attained income. The only production income the mineral owner can count on is what is already i the bank.
There are buyers who will pay upfront for an income stream with the backup of future production but their high risk is absorbed in the anticipation of expanded production, less sharp decline curves, and increasing product prices. Their discount rates to engineered projections are usually very, very large.
All pre-drilling evaluations are sight specific and adapted to the business plan of the operators who only know from experience if the well projections meet the business plan.
Hiring competent professionals is both expensive and time consuming.
An engineer should be able to answer the question with a simple decline curve. An experienced geologist with Petra software can run declines as well. It is simply a plot of producing against time, and after a rapid decline in the first 18 months or so, the rate of decline normally falls to 20-30% annually.
Your income will vary with price and production. Production declines invariably unless additional wells are drilled. Price varies as we see with the huge plunge in oil prices. Such a simple study of a single well should not cost over $1000.
Be very careful here. As others have pointed out, lending based on projected future production is a highly risky proposition. Not only will production steadily decline, but oil and gas prices are highly volatile (as we have recently seen). To make matters even worse, your client is a royalty owner and, as such, has no control over the operation of the well(s) in question.
There are only a dozen or so banks in the US that do oil and gas based lending and they typically have in-house engineers to help analyze the wells, and even then will only loan on a fraction (~60%) of the value.
Sounds like the Mortgagee isn't valuing that income stream as part of the appraisal of the property, rather is wanting to include it in the income statement. If the income has been around for 3 years it likely has declined by 70% if a typical well. From that point on, post-production costs go up and net royalty goes down at a slower rate - perhaps only 10 - 20% reduction per year. Again, a decline analysis could make some predictive estimates