Issue 3: Timing Can Reduce Taxes for Marcellus Shale Gas Landowners
by Taunya Knolles Rosenbloom, Esq. & Scott P. Borsack, Esq.
June 24, 2010
There are many time-worn sayings teaching us that acting too quickly or not quick enough can have negative consequences. The experience of landowners in the Marcellus Shale region have at times supported both sides of the coin. When dealing with taxes, particularly estate, inheritance and gift taxes, the consequences for failing to act or not acting soon enough can be significant. These taxes are all about value. The higher the value, the greater the tax. The more certainty in realizing the value, the fewer the discounts available to drive down the value.
In previous discussions in this space we have explored the very significant estate and inheritance taxes which can be due shortly after death for the landowner who does not properly and timely plan. Some will choose to wait until it is absolutely clear that their natural gas royalties have significant value. Others will assume that the rush to sign landowners to leases by large exploration companies must mean that someone knows something about the future value of the gas trapped below the surface. For those who act before the subsurface riches are brought through the pipelines running passed their property, the opportunity to reduce or eliminate taxes are very real. Wait until the determination of value is as simple as plugging numbers into a mathematical equation and opportunities are lost. In this case, factoring risk into the equation can yield a positive result. The time to plan is when risk is at its height.
In our last installment, we looked at a 400 acre parcel with five wells that might yield a value of $2.8 million per well considering a royalty rate of 20%. In our example, a well produced 3.0 MMcfe per day and the price of natural gas was assumed to be $5.00 per Mcfe. If the site could support five wells, the right to the natural gas royalty could be worth as much as $14.2 million. Until a well is actually drilled and fractured, all that anyone can do is guess about actual production. However, when a well is drilled and natural gas extracted, most of the guess work is over. Geologists can provide estimates of likely production over the life of a well once initial production is determined.
Additionally, there are a host of risks associated with the extraction of natural gas all of which impact upon the value of royalty rights. Some of those risks evaporate once production begins. For example, the landowner has no control over when exploration begins, and once it begins at what pace it is undertaken. Some exploration companies withhold drilling activities until several years after a lease is signed, and then not at capacity for some time. The exploration schedule can not be predicted. Until exploration begins no one can be sure about the yield of a well. There is pricing risk of the commodity, here natural gas. As the price in the marketplace fluctuates, so does the value of the royalty right. There are political risks to be considered as well. Drilling activity could be curtailed for any one of a number of reasons. New York State still has a drilling moratorium in place. What about environmental issues, ground water contamination and the potential problems which may be caused by water containing a witches brew of substances used to "frac" a well. There are transportation issues to be considered. How likely is full scale exploration when the site is far from existing pipe lines? How will royalty rights be affected by additional taxes that may be enacted in the future. All of these issues impact upon the value of gas royalties. In the aggregate these risks are greatest before production begins. Once a well starts to produce, many of these risks are addressed or eliminated.
Faced with the question of what natural gas royalties are worth today before any exploration has begun, considering the host of risks which negatively impact value, a valuation expert might suggest that the right is worth less today than it would be when many of the risks are resolved. Waiting until production begins eliminates many of the risks which could reduce the estimated value of royalty rights. The fewer the risks, the higher the value of the royalty right. The current market value of royalty rights for a site with a best case scenario for value of $14 million could actually be a fraction of that. Wait until the property starts producing natural gas and those discounts are lost and the market value will be higher than it is today.
The time to plan is now, before your property starts in production. In our next installment we will discuss some of the techniques and opportunities available to landowners now to deal with increasing royalty values.
June 24, 2010
There are many time-worn sayings teaching us that acting too quickly or not quick enough can have negative consequences. The experience of landowners in the Marcellus Shale region have at times supported both sides of the coin. When dealing with taxes, particularly estate, inheritance and gift taxes, the consequences for failing to act or not acting soon enough can be significant. These taxes are all about value. The higher the value, the greater the tax. The more certainty in realizing the value, the fewer the discounts available to drive down the value.
In previous discussions in this space we have explored the very significant estate and inheritance taxes which can be due shortly after death for the landowner who does not properly and timely plan. Some will choose to wait until it is absolutely clear that their natural gas royalties have significant value. Others will assume that the rush to sign landowners to leases by large exploration companies must mean that someone knows something about the future value of the gas trapped below the surface. For those who act before the subsurface riches are brought through the pipelines running passed their property, the opportunity to reduce or eliminate taxes are very real. Wait until the determination of value is as simple as plugging numbers into a mathematical equation and opportunities are lost. In this case, factoring risk into the equation can yield a positive result. The time to plan is when risk is at its height.
In our last installment, we looked at a 400 acre parcel with five wells that might yield a value of $2.8 million per well considering a royalty rate of 20%. In our example, a well produced 3.0 MMcfe per day and the price of natural gas was assumed to be $5.00 per Mcfe. If the site could support five wells, the right to the natural gas royalty could be worth as much as $14.2 million. Until a well is actually drilled and fractured, all that anyone can do is guess about actual production. However, when a well is drilled and natural gas extracted, most of the guess work is over. Geologists can provide estimates of likely production over the life of a well once initial production is determined.
Additionally, there are a host of risks associated with the extraction of natural gas all of which impact upon the value of royalty rights. Some of those risks evaporate once production begins. For example, the landowner has no control over when exploration begins, and once it begins at what pace it is undertaken. Some exploration companies withhold drilling activities until several years after a lease is signed, and then not at capacity for some time. The exploration schedule can not be predicted. Until exploration begins no one can be sure about the yield of a well. There is pricing risk of the commodity, here natural gas. As the price in the marketplace fluctuates, so does the value of the royalty right. There are political risks to be considered as well. Drilling activity could be curtailed for any one of a number of reasons. New York State still has a drilling moratorium in place. What about environmental issues, ground water contamination and the potential problems which may be caused by water containing a witches brew of substances used to "frac" a well. There are transportation issues to be considered. How likely is full scale exploration when the site is far from existing pipe lines? How will royalty rights be affected by additional taxes that may be enacted in the future. All of these issues impact upon the value of gas royalties. In the aggregate these risks are greatest before production begins. Once a well starts to produce, many of these risks are addressed or eliminated.
Faced with the question of what natural gas royalties are worth today before any exploration has begun, considering the host of risks which negatively impact value, a valuation expert might suggest that the right is worth less today than it would be when many of the risks are resolved. Waiting until production begins eliminates many of the risks which could reduce the estimated value of royalty rights. The fewer the risks, the higher the value of the royalty right. The current market value of royalty rights for a site with a best case scenario for value of $14 million could actually be a fraction of that. Wait until the property starts producing natural gas and those discounts are lost and the market value will be higher than it is today.
The time to plan is now, before your property starts in production. In our next installment we will discuss some of the techniques and opportunities available to landowners now to deal with increasing royalty values.