Are You Ready For The Explosion In Royalty Values?
By Scott P. Borsack
IT has begun. You probably missed IT and who could blame you. IT was subtle but inevitable. If you recall from the seminars that we have done over the past two years, I have been saying that royalty values were going to increase, and once they started, the pace would quicken each year. These changes would not depend upon whether there was exploration activity on your property. Rather, they were inevitable with the improvements in technology, changes in methodology and the realization that yields per well were greater than estimated. Right under our very noses, the exploration companies have quietly changed their drilling patterns. This has caused estimated royalty values to increase significantly. This is not a legal theory. The geologists and appraisers have changed their approach to valuation as they have learned of the changes in the field. When you factor into this new equation the increased yields per well that are disclosed every six months, values are going to continue to move in one direction – UP. Do you have a plan to deal with this? Do you have a plan at all? Have you done any planning?
When exploration companies first started to explore for natural gas in the Marcellus Shale region, they drilled one well to each 140 acres or so in a drilling unit. Last year exploration companies drilled one well to every 80 acres and we had begun to hear rumblings of theories that increasing the density – more wells for every drilling unit – would increase the yield. This year, in July to be exact, geologists and appraisers learned that exploration companies had begun to drill one well to every 50 acres of land. Is this significant? You betcha.
Under the old methodology, a landowner with 160 acres might expect two wells to be drilled on their property. Another way to think of it was that in a drilling unit of 640 acres, 8 wells could be drilled and our landowner with 160 acres would account for 25% of all royalties from activities in the production unit. Under the new methodology, 160 acres could support 3 wells. From the production unit point of view, almost 13 wells could be drilled on the property. This represents an increase in the number of wells in a production unit by 62%. With that increase comes a significant increase in royalties to landowners.
Last year geologists estimated that a well might produce a little more than 3 Bcf of natural gas over 30 years with royalties to the landowner of $2.7 million over 30 years. So a landowner in 2010 with 160 acres might think that over 30 years she would receive royalties of $5.4 million. In 2011, 160 acres would support 3 wells because exploration companies are now drilling wells on every 50 acres. So a 160 acre parcel would support three wells. Using 2010 estimates, three wells would produce $8.1 million in royalties over 30 years. Suddenly royalty values have markedly increased. But that’s not the end of the story.
Just this summer, geologists and appraisers have begun to estimate that a single well might produce more than 5.0 Bcf of gas over 30 years, yielding royalties of almost $3.6 million over that period of time. Consider the same 160 acre parcel discussed above, and our landowner might expect to receive $10.8 million over 30 years. Royalty values have doubled in one year. Again, is this significant? Of course it is.
Federal gift taxes and estate taxes are based upon value. Today, those taxes are assessed at the rate of 35%. In just 16 short months the rate for those taxes is increasing to 55%. And if that is not bad enough, the exemption against the tax is decreasing from $10 million for a married couple to $2 million for a married couple. What does all of this mean, you ask? It’s simple, higher tax rates and higher values means that if you have no plan, your family will pay higher taxes.
Under the current tax structure, our family with 160 acres will pay federal estate taxes of approximately $280,000 when the landowners die. If our landowners die in 2013, the royalty rights to 160 acres will generate a federal estate tax of $4,840,000. This is a 17 - fold increase in federal taxes. Do you have a plan?
This is only the beginning of the escalation in value and taxes. As geologists continue to learn about the true potential of a gas well drilled in the Marcellus Shale region, the estimated yield of a well will increase from its present 5.0 Bcf to 6.0 Bcf and then 7.0 Bcf and maybe as high as 8.0 Bcf. With each increase, the value of royalty rights will increase and the taxes due to pass interests in royalties will increase as well.
We have been anticipating these changes for two years. We have been talking about them in seminars and conference calls and in articles and alerts. These changes are beginning to impact the value of royalty rights. Can you afford not to have a plan in place to deal with these changes?
As always, we are available to assist you and your family to craft a plan to deal with these taxes. Please call Linda Hendricks at 215.864.7133 to schedule an in person or telephone conference.
IT has begun. You probably missed IT and who could blame you. IT was subtle but inevitable. If you recall from the seminars that we have done over the past two years, I have been saying that royalty values were going to increase, and once they started, the pace would quicken each year. These changes would not depend upon whether there was exploration activity on your property. Rather, they were inevitable with the improvements in technology, changes in methodology and the realization that yields per well were greater than estimated. Right under our very noses, the exploration companies have quietly changed their drilling patterns. This has caused estimated royalty values to increase significantly. This is not a legal theory. The geologists and appraisers have changed their approach to valuation as they have learned of the changes in the field. When you factor into this new equation the increased yields per well that are disclosed every six months, values are going to continue to move in one direction – UP. Do you have a plan to deal with this? Do you have a plan at all? Have you done any planning?
When exploration companies first started to explore for natural gas in the Marcellus Shale region, they drilled one well to each 140 acres or so in a drilling unit. Last year exploration companies drilled one well to every 80 acres and we had begun to hear rumblings of theories that increasing the density – more wells for every drilling unit – would increase the yield. This year, in July to be exact, geologists and appraisers learned that exploration companies had begun to drill one well to every 50 acres of land. Is this significant? You betcha.
Under the old methodology, a landowner with 160 acres might expect two wells to be drilled on their property. Another way to think of it was that in a drilling unit of 640 acres, 8 wells could be drilled and our landowner with 160 acres would account for 25% of all royalties from activities in the production unit. Under the new methodology, 160 acres could support 3 wells. From the production unit point of view, almost 13 wells could be drilled on the property. This represents an increase in the number of wells in a production unit by 62%. With that increase comes a significant increase in royalties to landowners.
Last year geologists estimated that a well might produce a little more than 3 Bcf of natural gas over 30 years with royalties to the landowner of $2.7 million over 30 years. So a landowner in 2010 with 160 acres might think that over 30 years she would receive royalties of $5.4 million. In 2011, 160 acres would support 3 wells because exploration companies are now drilling wells on every 50 acres. So a 160 acre parcel would support three wells. Using 2010 estimates, three wells would produce $8.1 million in royalties over 30 years. Suddenly royalty values have markedly increased. But that’s not the end of the story.
Just this summer, geologists and appraisers have begun to estimate that a single well might produce more than 5.0 Bcf of gas over 30 years, yielding royalties of almost $3.6 million over that period of time. Consider the same 160 acre parcel discussed above, and our landowner might expect to receive $10.8 million over 30 years. Royalty values have doubled in one year. Again, is this significant? Of course it is.
Federal gift taxes and estate taxes are based upon value. Today, those taxes are assessed at the rate of 35%. In just 16 short months the rate for those taxes is increasing to 55%. And if that is not bad enough, the exemption against the tax is decreasing from $10 million for a married couple to $2 million for a married couple. What does all of this mean, you ask? It’s simple, higher tax rates and higher values means that if you have no plan, your family will pay higher taxes.
Under the current tax structure, our family with 160 acres will pay federal estate taxes of approximately $280,000 when the landowners die. If our landowners die in 2013, the royalty rights to 160 acres will generate a federal estate tax of $4,840,000. This is a 17 - fold increase in federal taxes. Do you have a plan?
This is only the beginning of the escalation in value and taxes. As geologists continue to learn about the true potential of a gas well drilled in the Marcellus Shale region, the estimated yield of a well will increase from its present 5.0 Bcf to 6.0 Bcf and then 7.0 Bcf and maybe as high as 8.0 Bcf. With each increase, the value of royalty rights will increase and the taxes due to pass interests in royalties will increase as well.
We have been anticipating these changes for two years. We have been talking about them in seminars and conference calls and in articles and alerts. These changes are beginning to impact the value of royalty rights. Can you afford not to have a plan in place to deal with these changes?
As always, we are available to assist you and your family to craft a plan to deal with these taxes. Please call Linda Hendricks at 215.864.7133 to schedule an in person or telephone conference.