Property rights are often considered a “bundle of sticks” where a person can own varying interests in land. The person can own the entire bundle – called “fee simple.” Or, a person can own distinct and specific interests in a piece of property. One form of ownership is the ownership of only the oil and mineral rights found in or under a piece of land. This “asset” is typical of states like North Dakota or Oklahoma or Texas or Wyoming (and others). Though less common in the Northwest, many individuals in all parts of the county own oil and mineral rights. They might acquire them on their own or they might acquire ownership through inheritance or gift from their family members. The ownership of this asset presents complexities that both potential and existing owners should understand.
Unlike the ownership of a stock or bond, the ownership of oil and mineral rights is the ownership of real property – i.e. land. That means that the ownership of oil and mineral rights will subject that asset to probate in the state where the right exists. Most people try to limit the reach and expense of probate. The ownership of oil and mineral rights increases the likelihood of multiple probates and the associated expenses. As such, owners should consider this when putting together their estate plan by utilizing specific tools to deal with the assets. It might be a living trust that holds solely the oil and mineral rights. It might be a Transfer on Death Deed. It might be a gift of the asset prior to death. In any event the continued ownership adds complexity to the estate plan, the resulting probate, and the inevitable fractionalization of ownership of the asset as it becomes split among heirs.
The returns from the ownership of oil and mineral and gas interests typically come from the lease of those interests to companies that are trying to extract the same from the land. Accordingly, the lease payments are subject the actual content of the land, the ability of the company to extract the contents, and the global market for the contents of the land.
The asset is not readily marketable. That is, it is not easy to sell. If you want to sell your house or land, it is easy to contact a local realtor and get it listed on the MLS immediately. And, the proposed selling price is relatively easy to ascertain based on the mountains of currently available data. The sale of stocks or bonds or mutual funds are even easier. The sale price is published every second (for stocks) on the stock exchanges and the sale can happen in less than a second with the click of a button. In contrast, the value of oil and mineral rights can be very difficult to ascertain. It might require the use of an expensive appraiser local to the area and specializing in those rights. Then, the sale of the asset does not occur on any publicly available market like houses and stocks do, complicating efforts to sell.
It is rare that a person owns oil and mineral rights sufficient to deal directly with a major gas or oil or mining company. Rather, most people own a small piece (or a fraction of a small piece) of the total area that a big company might be interested in leasing. This necessarily means that, in order to enter into a successful leasing arrangement, the owner of the oil and mineral rights needs other owners to be similarly committed to the leasing arrangement and its terms. This weakens each individual owner’s position. In effect, it makes the owner a minority interest owner because his or her decisions can rarely be made in isolation.
Notably, this article conspicuously avoids the discussion of the actual returns obtained from oil and mineral rights leases. They may be quite lucrative. Or they might be abysmal. To determine the value of lease terms, it is essential to know the value of selling the asset. That is, if you sold the asset and invested elsewhere, could you beat the lease terms you are contemplating receiving. And, because a valuation is so difficult and there is no broad market for selling, it becomes difficult to glean the information necessary to determine whether the lease payments (returns) are good or not. And, the complexities of ownership outlined in this article should be considered along with the returns to really determine whether it is a good investment. All things being equal, perhaps a simpler asset is preferable to one that is complex.
* Licensed, not practicing.
The opinions voiced in this material are for general information only and not intended to provide specific advice or recommendations for any individual or entity. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment Advice offered through Cornerstone Wealth Strategies, Inc., a registered investment advisor and separate entity from LPL Financial.