The likelihood of actual drilling and the royalty rate offered are two factors to consider in weighing a leasing offer from an energy company
Lawrence J. DeFluri is managing partner of SevenBridge Financial Group in Harrisburg, Pa. Voices is an occasional feature of edited excerpts in which wealth managers address issues of interest to the advisory community.
In regions including Pennsylvania, where my firm is based, some families have learned that they have natural-gas reserves on their property. As a result, individuals come to me for guidance when an energy company approaches them about leasing part of their property for future drilling. This is often a complex scenario with potentially major financial consequences, so it’s important to understand this topic fully when taking on this type of client.
When an energy company requests to lease land, the initial offer may be well below what the company is actually willing to pay. Both the company’s original offer and the flexibility of that offer are a function of the value it places on your client’s land. On a property with large reserves, the signing bonus could reach $1,500 or $2,000 per acre and the royalties on each dollar of production could reach upward of 20%.
You should be willing to leverage the expertise of geological and petroleum consultants to understand what the client can get based on the broader market.
The likelihood of actual drilling on your client’s land is a key factor to take into account during negotiations. If there aren’t pipelines already nearby, there may be a lower chance of drilling during the course of the lease. If this is the case, a high promised royalty rate will actually have little impact on the amount a client can make. On the other hand, if drilling is substantial, even a quarter-percent increase or decrease in the royalty rate could have major financial implications.
In most cases your work won’t be finished once a lease is negotiated. You will then need to advise the client on allocating the new funds and managing whatever cash flow is generated by royalties. Depending on commodity prices and the type of wells that are put in, your client may experience wide fluctuations in royalty revenue over time. In these cases, it’s a key task of the adviser to integrate varying cash flows into a broad financial strategy, as well as to help estimate if and when these cash flows will deplete.
I have found these clients rewarding to work with because they can benefit so strongly from our assistance. By knowing how to help families negotiate leases to energy companies, you can give them a key financial advantage and open your practice up to a substantial number of new clients.