Production Data to Pennsylvania Department of Environmental Protection Blows the Top Off Appraisal Models
By Scott Borsack
The Pennsylvania Department of Environmental Protection last week released Marcellus Shale production data. This data was gathered from drilling companies and includes actual production amounts from wells during a one-year period ending July 1, 2010. Not all drilling companies reported information by the deadline, but the Commonwealth has announced its intention to get information from all companies in the future.
There were several surprises buried in the data, but the part that was the most shocking is that actual natural gas production from existing wells greatly exceeded earlier estimates. The highest producing wells thus far are located in Bradford, Tioga and Susquehanna Counties. The highest producing well in the Commonwealth yielded more than 2 million cubic feet of gas in the 12-month reporting period. The average annual output of a well in Bradford County during the reporting period was in excess of 1 million cubic feet of natural gas. Geologists' models for valuing royalties prior to the release of this data assumed that first year production was going to be 650,000 cubic feet per year. Actual production is two or three times greater than these models predicted. Valuations of royalty rights are sure to skyrocket shortly.
This is wonderful news for royalty calculations. It is bad news for those of you who will benefit from natural gas royalties, but have not yet put an estate plan in effect.
A quick review of our seminar presentation will help clarify:
-- Proper estate planning can reduce the tax burden on your family. Proper planning, in a great number of Marcellus Shale cases, includes creating a family limited partnership (FLP) and assigning royalty rights to the FLP.
-- Taxes on FLP assets are based on the value of the assets at the time they are transferred to the FLP. An asset appraisal occurs at the time of transfer. What happens after the transfer is not relevant.
-- Appraisals are based on all available information at the time of the transfer. Less information equals less certainty about future royalty payments, which equals a lower appraisal. More information means more certainty and has the opposite effect – a higher appraisal.
The "more information" generated by the DEP last week will increase royalty values while driving gift, estate and inheritance taxes even higher. As the DEP continues to collect and release more and more data from the drilling companies, potential tax burdens will grow higher, placing even more of a strain on your family in the event of your death. By law, drilling companies must provide additional reports every six months. That means that information will be regularly available to continue the march of higher royalty values. As values increase so too will tax burdens.
The time to create an estate plan is now, before asset appraisals increase. As knowledge improves and experience increases with Marcellus wells, geologists will better understand the potential of the Marcellus Shale formation. Estimates of gas reserves and gas production will become more reliable at the same time. As more production data is gathered, the models used to appraise the value of Marcellus Shale natural gas royalties will show greater lifetime production. With the increases in lifetime production come increases in value. Appraisers and geologists will soon begin to modify their valuation models and their valuations will increase. The increase in valuation means that gift and estate taxes will increase as well. The opportunity to plan at the lowest possible values is beginning to fade. Regular data reporting to the Department of Environmental Protection will only hasten the end of this incredible valuation opportunity. Do not wait this out on the sidelines – only the tax man stands to benefit.
The Pennsylvania Department of Environmental Protection last week released Marcellus Shale production data. This data was gathered from drilling companies and includes actual production amounts from wells during a one-year period ending July 1, 2010. Not all drilling companies reported information by the deadline, but the Commonwealth has announced its intention to get information from all companies in the future.
There were several surprises buried in the data, but the part that was the most shocking is that actual natural gas production from existing wells greatly exceeded earlier estimates. The highest producing wells thus far are located in Bradford, Tioga and Susquehanna Counties. The highest producing well in the Commonwealth yielded more than 2 million cubic feet of gas in the 12-month reporting period. The average annual output of a well in Bradford County during the reporting period was in excess of 1 million cubic feet of natural gas. Geologists' models for valuing royalties prior to the release of this data assumed that first year production was going to be 650,000 cubic feet per year. Actual production is two or three times greater than these models predicted. Valuations of royalty rights are sure to skyrocket shortly.
This is wonderful news for royalty calculations. It is bad news for those of you who will benefit from natural gas royalties, but have not yet put an estate plan in effect.
A quick review of our seminar presentation will help clarify:
-- Proper estate planning can reduce the tax burden on your family. Proper planning, in a great number of Marcellus Shale cases, includes creating a family limited partnership (FLP) and assigning royalty rights to the FLP.
-- Taxes on FLP assets are based on the value of the assets at the time they are transferred to the FLP. An asset appraisal occurs at the time of transfer. What happens after the transfer is not relevant.
-- Appraisals are based on all available information at the time of the transfer. Less information equals less certainty about future royalty payments, which equals a lower appraisal. More information means more certainty and has the opposite effect – a higher appraisal.
The "more information" generated by the DEP last week will increase royalty values while driving gift, estate and inheritance taxes even higher. As the DEP continues to collect and release more and more data from the drilling companies, potential tax burdens will grow higher, placing even more of a strain on your family in the event of your death. By law, drilling companies must provide additional reports every six months. That means that information will be regularly available to continue the march of higher royalty values. As values increase so too will tax burdens.
The time to create an estate plan is now, before asset appraisals increase. As knowledge improves and experience increases with Marcellus wells, geologists will better understand the potential of the Marcellus Shale formation. Estimates of gas reserves and gas production will become more reliable at the same time. As more production data is gathered, the models used to appraise the value of Marcellus Shale natural gas royalties will show greater lifetime production. With the increases in lifetime production come increases in value. Appraisers and geologists will soon begin to modify their valuation models and their valuations will increase. The increase in valuation means that gift and estate taxes will increase as well. The opportunity to plan at the lowest possible values is beginning to fade. Regular data reporting to the Department of Environmental Protection will only hasten the end of this incredible valuation opportunity. Do not wait this out on the sidelines – only the tax man stands to benefit.