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The effects of mineral interests on land appraisals in shale gas regions.

ABSTRACT

Mineral interests and the issues that appraisers must consider in regions impacted by shale gas formations are the subject of this article. The Barnett Shale in North Central Texas is discussed in the example; however, the issues and concepts apply to many states with shale gas formations. Emphasis is placed on the need for appraisers to focus on mineral estates attached to, or severed from, subject properties and comparable sales when valuing land. The effects of severing the mineral estate from the surface estate and the resulting value implications, including the dominance of the mineral estate, are major topics in this article. References are provided to case law on mineral estate dominance, oil and gas law in Texas, and oil and gas valuation for court. An example case demonstrates the sales comparison approach.

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When advances in drilling and fracturing technology made shale gas production feasible, mineral estates once believed to have little or no value became potentially very valuable and appraising this land became more complex than a routine appraisal of the fee simple estate.

For years, geologists reported the existence of significant quantities of natural gas in Texas in the subterranean formation known as the Barnett Shale, but economically feasible methods of extracting the gas did not exist. Appraisers as well as buyers and sellers paid little attention to whether or not mineral interests were included in land sales. As the market realized that almost every acre in several Texas counties above the Barnett Shale could produce natural gas profitably, the appraisal of the land became more problematic. Similar shale gas formations create the same appraisal challenges in over fifteen other states. Figure 1 shows the locations of major shale gas basins. (See the Appendix for a state listing).

This article highlights and discusses many of the relevant issues in appraising properties located above the Barnett Shale, including severance of the mineral estate from the surface estate and the value implications thereof; the dominance of the mineral estate over the surface estate; and the nature of the interest created by oil and gas leases. Also, a discussion is presented as to when the sales comparison approach should be used versus when an oil and gas appraisal expert should be called on for a valuation assignment. The article concludes with a simple example of appraising shale gas land with and without mineral estates attached.

Appraisal Requirements, Regulations, and Guidance

The requirements, regulations, and guidance for valuing mineral interests--and more particularly their influence on land values--are dispersed among regulatory bodies, laws, and standards of professional practice. (1) In the United States, mineral property valuation is addressed by regulations and standards from a number of sources including the following:

* American Institute of Minerals Appraisers (ALMA)

* Appraisal Institute (AI)

* Federal Financial Institutions Reform, Recovery and Enforcement Act (FIRREA)

* International Valuation Standards (IVS) (2)

* International Accounting Standards Board (IASB)

* Securities and Exchange Commission (SEC)

* Uniform Appraisal Standards for Federal Land Acquisitions

* Uniform Standards of Professional Appraisal Practice (USPAP)

[FIGURE 1 OMITTED]

As a litigation attorney in this field has stated,
   Determining the value of oil and gas properties is a
   continuing problem in litigation. There are a number
   of issues to be addressed in considering the value of oil
   and gas assets. Primary among these are (1) substantive
   issues relating to the methodology of valuing oil gas
   assets, and (2) evidentiary issues (3)


Mineral and Surface Estates

Severing land into two interests or estates, surface and minerals, is a common practice in the United States. Appraisers need to be familiar with local and state laws that have jurisdiction over these estates. The Texas Railroad Commission, the entity charged with regulating oil and gas production in Texas, has stated as follows on the issue of severance of surface and mineral interests:
   Under Texas law, landownership includes two distinct
   sets of rights, or "estates," the surface estate and the
   mineral estate. Initially, these two estates were owned
   by the same person and they may continue to be owned
   together by one person. However, in many areas of
   Texas, especially those where there has been extensive
   historical oil and gas development, it is common for
   the mineral estate and surface estate to be owned by
   different people. The division, or "severance," of the
   mineral estate and surface estate occurs when an owner
   sells the surface and retains all or part of the minerals
   (or, less commonly, an owner sells the minerals and
   retains the surface). If an owner does not expressly
   retain the minerals when selling the surface, the mineral
   estate he owns automatically is included in the sale. (4)
   [Emphasis added.]


The surface estate is an interest in the estate overlying a mineral estate. The mineral estate is a collection of subsurface rights, which are defined as "the rights to the use and profits of the underground portion of a designated property; usually refers to the right to extract minerals such as oil, gas or other hydrocarbon substances as designated in the grant; may include a right-of-way over designated portions of the surface." (5) [Emphasis added.]

The severance issue is important when valuing mineral estates. A logical way for land appraisers to view property rights with respect to the severance issue is to think in terms of the following scenarios:

1. The surface with minerals never having been severed, in which case conveyance would include the whole property--surface and mineral estates--unless the mineral interests are reserved in the deed.

2. The surface with all or some of the minerals conveyed away, as by mineral deed.

3. The surface with minerals under lease, with royalty and possibility of a reversion in the event the lease expires. (6)

The appraiser must be clear about which property rights are to be appraised, and if or when there are separate rights requiring multiple value opinions.

Dominance of the Mineral Estate

The mineral estate has dominance over the surface estate in virtually every state. Were that not the case, the severed mineral estate would be of little or no value to the owner. (7) The ramifications of mineral estate dominance are considerable:
   The basic premise of the dominant estate rule is that
   the mineral owner (or the operator as a lessee of the
   minerals) is permitted to use as much of the surface
   as is reasonably necessary to explore for and produce
   the minerals. That means that unless lease provisions,
   statutes or local ordinances intervene and impose more
   stringent requirements, the operator has the right of
   ingress and egress over the surface, need not pay for
   using the surface to install tanks or machinery, may
   use the tract's water whether above or below ground,
   and need not even restore the surface after completion
   and abandonment of drilling activities. (8)


In the United States, the concept of mineral estate dominance came from English common law and Mexican law. (9) Almost every court that deals with surface damage and surface usage has now adopted four basic common law rules or principles:
   (1) The mineral estate is the dominant estate, (2) the
   mineral estate has the right to access minerals and use
   as much of the surface as reasonably necessary to extract
   and carry away the minerals, (5) the mineral owner does
   not have the right to destroy the surface unless that
   right was expressly granted in the conveyance, (4) the
   mineral owner [is] only liable to the surface owner for
   damages to growing crops and existing structures, but
   not for any other damages to the surface resulting from
   "reasonably necessary" surface activity. (10)


The mineral dominance issue is consistently litigated in the West. The root of the question is the extent of surface use that is allowed for mineral development. States have two perspectives: due regard and reasonable accommodation. Most states follow the due regard principle, which allows the mineral owner to use as much of the surface as reasonably necessary but requires compensation for damage to crops and structures. (11)

An accommodation doctrine has been adopted by several states, including Colorado and Texas. The doctrine provides some relief to the surface owner inasmuch as the mineral lessee must respect, as far as is practical, the surface owner's uses and not lay waste to the property. (12) Examples include specified distances from drill sites to buildings, restrictions on use of water from the property, and location and depth of pipelines. The burden of proof in using the accommodation doctrine is on the surface owner. There must be an existing use or planned use of the surface. The planned use must be more than a statement of "I was planning to subdivide this property," but it need not be actual construction; however, platting of the land would show clear intent. Notwithstanding the foregoing comments, the mineral owner's surface activities and appurtenances needed to exploit the minerals may hinder the surface owner's future development of the land. Severing the mineral estate from the surface almost always diminishes the value of the surface. As Asabere and Huffman state, "An encumbrance that unbundles rights in a parcel of real estate and transfers some rights to another entity cannot fail to diminish the value of the encumbered property." (13)

While these are common law principles, some states have enacted statutes to protect surface owners. The evolution of surface owners' statutory rights began in 1978 with the State of North Dakota passing the state's Oil and Gas Production Damage Compensation Act (14) (North Dakota Act), which served as the model for affording surface owners legislative protection with respect to oil and gas leases. (15) The North Dakota Act withstood court challenges by the oil and gas industry. Oklahoma, Montana, and South Dakota followed North Dakota by passing legislation to give surface owners some amount of protection. (16) In Oklahoma, surface owners and mineral interest owners must agree to a dollar amount to compensate the surface owners for damages, which may involve both parties obtaining separate appraisals to come to a settlement. Wyoming is another example, where the mineral owner (or the lessee) must engage in good-faith negotiation for a surface use agreement before mineral development. However, the mineral owner can post a bond with the conservation commission if the surface owner is recalcitrant. (17)

A surface waiver limits the mineral lessee's rights to operate on the surface, including ingress and egress, placing a drilling rig or well on the surface, or even setting foot on the surface above the mineral estate leased and controlled by the lessee. This is possible and often acceptable because the lessee can access the minerals from a distant property using horizontal drilling techniques. A surface waiver protects the surface estate from oil and gas well development activity. (18)

The Nature of Interests Created by an Oil and Gas Lease

Prior to severance, the owner of the mineral estate typically grants a mineral lease to an exploration and production company, which is the mineral lessee. It is important for the appraiser to identify the nature of the lease provisions. The owner of the mineral estate, i.e., the lessor, will receive royalty payments from the lessee if and when minerals are produced and sold. The size of the share agreed upon in the lease is typically between one-eight and one-fourth of the gross sales. A mineral lease is an actual conveyance of real property. In Texas, an oil and gas lease conveys a fee simple determinable interest in the oil and gas in place. There is a reversionary interest back to the lessor when and if the lease expires. (19)

Valuation Issues

When the mineral interests are relevant, the appraiser must take extra care to adequately describe the interest being appraised and the scope of the work. The appraiser must specify that the value estimate is for the surface estate or the mineral estate, or a combination thereof if the two have not been severed. (20) If the subject property includes the surface and mineral estates combined, the unit rule prohibits a summation of two separate appraisals to arrive at a single value of the subject, especially if the values were provided by two different appraisers. The Uniform Appraisal Standards for Federal Land Acquisitions provides solid advice on the importance of the unit rule when appraising land with minerals:
   The courts have recognized that property must be
   valued as a whole for federal acquisition purposes, with
   due consideration of all of the components that make up
   its value ... "In the case of land that is underlaid with
   marketable minerals, ... the existence of those minerals
   is a factor of value to be considered in determining the
   market value of the property," ... [but] it is improper
   for an appraiser to estimate the value of the surface of
   the property, add to it a valuation of the minerals, as
   estimated by a separate minerals expert, and thereby
   conclude a total market value for the property. (21)


In describing the interest being appraised, the appraiser should verify and disclose the status of the mineral interest included. If all or part of the mineral interest has been severed from the surface estate, it is essential to disclose the percentage of the mineral interest included in the appraisal. Regarding comparable sales, the appraiser must determine the percentage of the mineral interest conveyed and, if it differs from the subject, make the necessary adjustments.

The scope of work should describe the lengths to which the appraiser has gone to estimate value, such as using comparable sales with similar mineral interests discussed in enough detail to satisfy the Scope of Work Rule. (22) For appraisals using the discounted cash flow approach, the scope will describe steps taken to estimate reserves and net cash flows.

When Does an Appraisal Assignment Require an Oil and Gas Appraiser?

When is a land appraiser qualified to opine on the value of oil and gas properties? There are no hard and fast rules. In general, if there is no production in the area and no proprietary or public seismographic data, or even though there is production in the same shale formation but at a distance, a land appraiser is qualified and capable of using the sales comparison approach to value the property. (23)

On the other hand, if there is oil and gas production on or in close proximity to the subject property, and if properties in the area are trading primarily for their mineral value, the subject should be valued using an income capitalization approach (i.e., discounted net cash flow) and the appraisal should be conducted by an expert in the appraisal of oil and gas properties. Geologist and petroleum engineers (reservoir engineers) have an accepted methodology of classifying and quantifying recoverable reserves based on information obtained from drilled wells on or near the subject property or from seismic studies in the area. In shale gas areas, geologists consider the shale formation's thickness, porosity, and permeability. Quantities of recoverable reserves--which the Society of Petroleum Engineers classifies as either proved, probable, possible, or exploratory--are estimated by a geologist or reservoir engineer. Based on the reservoir report, a decline curve is used to estimate hydrocarbon production, which is then translated into cash flows based on estimates for future oil or gas prices. Estimated drilling and production costs are deducted from gross oil and gas sales to arrive at net cash flows. The estimated future net cash flows are then discounted to a present value using a discount rate that is in the magnitude of 10%. That present value is further reduced to reflect the degree of uncertainty about future production and prices. The important point is that appraising oil and gas properties requires the use of complex production forecasts and a sophisticated income capitalization approach that most land appraiser are not qualified to employ. (24)

If comparable sales are available and recoverable reserves can be estimated, both the sales comparison approach and the income capitalization approach should be used. The Uniform Appraisal Standards for Federal Land Acquisitions states the following:
   As in the valuation of other property for federal
   acquisition purposes, if adequate sales data is available,
   the sales comparison approach is usually considered
   the best evidence of value. (25)


One land appraiser in the Barnett Shale reported that he accepted an assignment to appraise land and minerals in production. Recognizing that he was unqualified to value the mineral estate, he personally valued the surface and engaged an expert in oil and gas appraisal to value the mineral estate. Instead of reporting the sum of the two appraisals, which would have violated the unit rule, he reported two separate values.

Sales Comparison Approach

The sales comparison approach is the primary focus of this discussion, as it will be the approach used by appraisers where there is no current oil and gas production.

Comparability of sales data selected for the sales comparison approach requires consideration of many factors pertaining to the surface and mineral estates. The surface estate factors include the usual components: time of sale, size, highest and best use, surface improvements, and location. The factors relating to the mineral estate include rights conveyed, percentage of mineral interest conveyed, time of sale, and suitability of the site for drilling. If significant information is available regarding potential production, that should be utilized in an income capitalization approach.

The following discusses factors related to surface and mineral estates that are considered in the sales comparison approach.

Rights Conveyed

Rights conveyed with the comparable sale should mirror the interests being appraised. If the surface and mineral estates have been severed, the surface estate appraisal must consider the consequences of the mineral owner's surface activities. Is there a surface waver in place on the subject or the comparable sales? If not, what effect does current or future production activity have on the market value of land? With regard to the mineral interests, which elements of the possible rights remain attached to the subject and comparable sales? The owner of a mineral interest has executive rights, i.e., the right to grant leases. These rights have value because they include the decision of when and whether to lease the property for oil and gas production. Executive rights also include a claim to any leasing fee or signing bonus. A signing bonus can be a very large part of the value in the mineral interest.

Time of Sale

Time of sale is always a factor considered in the sales comparison approach. Time of sale is especially important in assignments related to the Barnett Shale because of the effect volatile oil and gas prices have on prices paid for mineral interests. In the most productive geographical regions of the Barnett Shale, lease-signing bonuses have fluctuated from a low of $1,000 per acre to a high of $25,000 and then back down again. These price changes were highly correlated with the rise and fall of natural gas prices, which fluctuated from $3.00 to $13.00 per MBTUs. (26) Prices paid for land with mineral interests behaved accordingly.

Surface Improvements

Surface improvements complicate the comparison process, especially when the subject and comparable sales have significantly different improvements. For example, in one instance a neighborhood shopping center was purchased for use as a drill site. The company demolished the center, which was located at the intersection of a freeway and major street. They are drilling several directional wells at the site and allegedly plan to redevelop the unused acreage. Clearly, the drilling company believed the highest and best use had changed from shopping center to drill site.

Suitability of the Surface for Drilling and Production

Suitability of the surface for drilling and production affects the cost of getting the gas out of the ground and to the market. Operating companies will pay more for properties that present fewer inhibiters to drilling and production. Suitability issues include legal or regulatory jurisdiction; access to product markets; surface terrain; suitable drilling location; and availability of large quantities of water for fracking.

Percentage of Minerals Owned and Conveyed

The percentage of minerals owned and conveyed is a key factor in comparing land sales. It is common for owners when selling their land to reserve all or part of the minerals for themselves--thus, selling the surface only or the surface and part of the mineral interest. The owner of a mineral interest has executive rights, which include the right to sign an oil and gas lease, assuming there is no current lease, and the right to a share of the signing bonus.

Alternatively, a seller can reserve a nonparticipating" royalty interest (NPRI), which carries no executive rights. The owner of the NPRI has no ability to lease his or her interest and will not receive any of the bonus money. The NPRI owner benefits from the mineral interest after a well is paying royalties. Before the oil and gas lease has been signed, a mineral interest can be more valuable than a royalty interest. After the signing bonus, there is little or no difference in value.

Surface Waiver

The existence of a surface waiver also can be a very important factor. The value of the severed surface estate can be greater if there is no possibility of the mineral interest owner operating on or encumbering the surface. This is particularly true for smaller properties. The value of the mineral interest beneath land with a surface waiver will be diminished if there is no nearby site from which the lessee can drill and gain access to the minerals.

Mineral Deed

A mineral deed is the best way to accurately ascertain the amount paid for a mineral estate. However, seldom, if ever, are two mineral estates the same. Mineral estate sales can differ in many ways, including geographical area, leased or not leased, and quantity of recoverable reserves.

On average, the Barnett Shale is 500 feet thick, but it varies from 50 feet at the outer edges of the formation to 700 feet at its thickest point. Over a period of years (2006-2008), geologists conducted seismographic studies to map the depth and thickness of the Barnett Shale. Gas exploration and production companies paid much greater signing bonuses to lease the land above the thickest regions of the shale formation. Once the map of this geological information was generally available (about 2008), shale thickness, as well as porosity and permeability became important drivers of leasing bonuses and sale prices for mineral interests.

Sales Comparison Example

Analyzing Comparable Sales to Estimate Value of Land with and without Minerals

The impetus for this article came from an appraisal assignment requested by a title company that was liable for failing to discover and inform a buyer that the land he was purchasing did not include the underlying mineral estate. (27)

To establish a settlement amount, the title company instructed the appraiser to value the land, first with all of the mineral interest attached and second without the mineral estate. The client and intended users of the appraisal are the title company (which shall go unnamed), its representatives, and the court. The appraisal will be used to provide an opinion of market value of the subject property with the insured risk and without the insured risk, i.e., the mineral estate.

The Texas courts have defined market value as follows:
   The price which the properly would bring when it is
   offered for sale by one who desires, but is not obliged
   to sell, and is bought by one who is under no necessity
   of buying it, taking into consideration all of the uses to
   which it is reasonably adaptable and for which it either
   is or in all probability will become available within the
   reasonable future. (28)


The interest valued in this example case is the fee simple title, encumbered by any easements not to be extinguished, less oil, gas, and other hydrocarbons, i.e., the surface only; and the fee simple title, including both the surface and mineral estates.

The property is identified as 200 acres of ranch land consisting of mostly native pasture. It is further identified by a survey drawing and metes and bounds description. The appraiser personally inspected the entire ranch. Highest and best use is the present use as an agricultural operation. The effective date of valuation is the date of the claim that the title policy failed, December 2005. The final value estimates will reflect the value of the property with and without the mineral estate, the difference being the contributory value of the mineral estate.

The scope of work included verification of each comparable sale with one of the parties to the transaction or the agent(s) involved in the sale. Verification included the sale price, terms, the reservation or conveyance of minerals, and any special circumstances, such as a surface waiver, that may have influenced the consideration. These sales were then paired as to surface-only conveyances or conveyance of surface and minerals. In this example case, an adjustment factor is determined from the sales analysis and that information is used to arrive at a value of the land with and without minerals as indicated by the sales comparison approach. (29)

Five sales of ranch land with different percentages of mineral interest reserved or conveyed were found and confirmed. All the comparable sales were vacant land in the same soil conservation district. The surface estate characteristics were very similar and judged to be of equal value per acre. Thus, no other adjustments were needed and the primary price difference between the tracts was attributed to the mineral interests. (30)

Finding sales of minerals-only in the Barnett Shale proved to be difficult. One example was found in the vicinity of the subject that had aspects of a minerals-only sale. However, price information gained from a sale of mineral interests without the land is theoretically different from the contributory price of minerals, either some or all, when sold with the surface estate. Therefore, special care was taken in using that sale. The best alternative would be to find vacant or minimally improved surface-only sales to compare to land sales with all or some of the minerals intact. Comparable sales of land with differing percentages of minerals intact provide the most useful information.

In this example, the five recent ranch-land sales in a single Texas county in the Barnett Shale region provide a basis for discussion of some of the issues affecting the sales comparison approach to valuing land with and without minerals. The subject property, as well as all of the sales, were above the Barnett Shale but near its farthest reaches. At the date of value, it was not known if drilling activity would reach this far south. Consequently, land and mineral sales were based solely on the sales comparison approach, as insufficient information existed to allow for an income capitalization approach to value.

Comparable Sales Data

Mineral Estate-Only Sales. Sale 1 includes a minerals-only component and an accompanying sale of land with all of the minerals. This sale occurred on October 1, 2004. The buyer agreed to purchase 160 acres of land with all of the minerals (Sale 1a) for $407,000 ($2,544 per acre) and paid an additional $48,375 ($645 per mineral acre) for 100% of the minerals under an adjoining 75-acre tract of land (Sale 1b). (31)
Sale 1a   Surface and     160 acres   $2,544 per acre
          100% Minerals

Sale 1b   Minerals Only   75 acres    $645 per acre


Surface Estate-Only Sale. Sale 2 is a surface-only sale of 120 acres with no minerals attached. It sold on April 1, 2005, for $2,545 per acre. The property is easily accessible and mostly native grassland pasture. The terrain features are relatively level, and there is an approximate 25% canopy (32) This sale provides a good base case for the value of the surface estate only.
Sale 2     Surface Only     120 acres     $2,545 per acre


Surface Estate Salewith 100% of the Minerals. Both Sale 1a (as described) and Sale 3 are sales of land plus 100% of the minerals.

Sale 3 includes 128 acres of land with 100% of the minerals. It sold for $2,686 per acre on October 20, 2005, six months after Sale 2. The surface characteristics of Sale 2 and Sale 3 are comparable, thus providing a good pairing with the only difference being the minerals in Sale 3. That is, both tracts fall into the same land-use classification and are similar in all other characteristics except for the mineral estate conveyed. A comparison between Sale 2 and Sale 3 indicates that the contributory value of the mineral estate is $541 per acre.
Sale 3       Surface and     128 acres   $2,686 per acre
             100% Minerals

Sale 2       Surface Only    120 acres   $2,345 per acre

Difference   100% Minerals   Value per   $341 per acre
                             Mineral
                             Acre


Sale 1a is for land plus 100% of the minerals, with a price of $2,544 per acre. Comparing Sale 1a to Sale 2 indicates that the minerals contributed $199.
Sale 1a      Surface and     160 acres   $2,544 per acre
             100% Minerals

Sale 2       Surface Only    120 acres   $2,345 per acre

Difference   100% Minerals   Value per   $199 per acre
                             Mineral
                             Acre


Surface Estate Sale with Less than 100% of the Mineral Estate. Sale 4 is for 120.86 acres of land with 75O/o of the mineral estate conveyed. The sale price was $2,488 per acre; however, this sale has an inferior location that warrants a positive price adjustment of $100 per acre. The adjusted price for Sale 4 is $2,588. The sale date was August 12, 2005, very near the time of Sale 2 and Sale 3. Comparing Sale 2, at $2,345 per acre and no minerals, with Sale 4, at $2,588 per acre and 75% of the minerals, the difference is $243 per acre, which indicates the contributory value of a mineral acre when sold with the surface estate is $324 per acre ($243/.75).
Sale 4       Surface and    120.86 acres   $2,588 per acre
             75% Minerals

Sale 2       Surface Only   l20 acres      $2,345 per acre

Difference   75% Minerals   Value per      $243/.75 = $324
                            Mineral
                            Acre


Alternatively, if Sale 3 with 100% minerals is compared to Sale 4 with only 75% minerals, the difference in price is $98 ($2,686-$2,588). The difference in minerals was 25%. Given there are no physical characteristics or infrastructure differences of significance, this pairing indicates that minerals are worth $392 ($98/.25) per acre.
Sale 3       Surface and     128 acres      $2,686 per acre
             100% Minerals

Sale 4       Surface and     120.86 acres   $2,588 per acre
             75% Minerals

Difference   25% Minerals    Value per      $98/.25 = $392
                             Mineral
                             Acre


Sale 5 is for a 396-acre tract that includes 50% of the mineral estate and sold for $2,502 per acre on July 1, 2005. The surface estate is similar to Sale 2, a surface-only sale for $2,345 that occurred three months earlier. With a price difference of $157, which can be attributed to the 50% mineral difference, Sale 5 indicates that minerals are worth $314 per acre ($157/.50).
Sale 5       Surface and    396 acres   $2,502 per acre
             50% Minerals

Sale 2       Surface Only   120 acres   $2,345 per acre

Difference   50% Minerals   Value per   $157/.50 = $314
                            Mineral
                            Acre


Summary of the Values Indicated by Comparable Sales

One may draw several conclusions from the preceding sales and paired analyses. A pairing of Sale 1a and Sale 2 indicates that minerals with the land are worth $199. The pairing of Sale 2 and Sale 3 indicates that minerals are worth $341 per acre. Sale 2 compared to Sale 4 indicates $324 per mineral acre. Sale3 compared to Sale 4 indicates $392 per acre, and Sale 5 compared to Sale 2 indicates $314 per acre.

The paired sales in Table 1 present five indications of value. After adjusting for the location of Sale 4, the properties are similar enough to weight the resulting difference from each pair equally. The average contributory value of minerals with land is $314 per acre. Using $314 as the adjustment factor, the value of land with and without minerals can be estimated.

Based on the information from the sales adjustment grid shown in Table 2, the value of subject property with all of the mineral estate attached is $2,643 per acre. That same land without minerals is worth $2,329 per acre. The standard deviation of the land values indicated by the paired sales is $55.94 for land with or without minerals. The charge by the client, an attorney for the title company, is to find the value of the land with and without the minerals in December 2005. The indications that can be drawn from this analysis are the value of the subject 200 acres of ranch land with minerals was $528,600 ($2,643 x 200). Without minerals, the value was $465,800 ($2,329 x 200).

Summary and Conclusion

It is imperative that appraisers overtly consider mineral interests attached to both the subject and the comparable sales when valuing properties in regions known to have shale formations rich in natural gas like the Barnett Shale in North Central Texas. Extra care must be taken in stating the interest being appraised and the scope of work where mineral interests are of significant value. Failure to consider the minerals can result in erroneous value estimates. In the introduction of this article, eight sources of standards and guidance for appraising land with mineral interests are listed. In addition, much of the case law pertaining to valuing oil and gas assets can be found on the Internet. (33)

Where subsurface minerals have value, it is common to separate the mineral estate from the surface estate. Once severed, the two estates can be bought and sold separately. The mineral estate is dominant over the surface. That means even though the mineral owner does not own the surface, he or she can, within reason, come onto the property with equipment and drilling rigs; build roads and well sites; and use the surface water or drill water wells with little or no consultation with the landowner: The concept of mineral estate dominance is well established in US common law (34) Appraisers must consider the adverse impact of mineral estate dominance on the value of the surface. In Texas, the accommodation doctrine provides some relief to landowners. A surface waiver written into the mineral lease will change the dominance issue to favor the landowner and protect the value of the surface but at a cost to the mineral owner and lessee. Although mineral estate dominance theory is rooted in common law, recently written laws in some states offer surface owners a level of protection against mineral dominance.

Appraisers must clearly specify that they have estimated the value of the surface estate, or the mineral estate, or a combination of the two. One of the valuation issues highlighted in this article is the unit rule, which prohibits the valuing the surface estate and the minerals separately and adding the two together to arrive at a single value estimate for the whole property. In a situation where the two estates must be valued separately, two separate values, one for the surface and the other for the minerals should be reported.

When estimating the value of a mineral interest that is currently producing oil and gas, the income capitalization approach is appropriate but requires special expertise. The Uniform Appraisal Standards for Federal Land Acquisitions states that when adequate sales comparison data is available, the sales comparison approach is preferable. Once seismologists/geologists have adequately mapped an area for the location, thickness, porosity, and permeability of the shale formation, that information is central to the value of mineral estates.

This article has focused primarily on the sales comparison approach. The important elements of comparison include interests conveyed, time of sale, and suitability for drilling and production. The appraiser must know the importance of a mineral interest with executive rights versus a non-participating royalty interest and the value of a surface waiver to the landowner.

The example case presented demonstrates how to use comparable sales to estimate the market value of land with minerals and without the minerals. The example also shows how to estimate values using sales of land with less than all of the minerals.

Land appraisers presented with the opportunity to estimate land values in shale gas regions are encouraged to familiarize themselves with the concepts discussed here and to review the key sources cited for information pertaining to appraisal standards; oil and gas valuation; dominance law; and oil and gas law.

Appendix

States with Shale Gas Formations

The following is a list of the major shale gas formations and the states in which the majority of the formation is located:

* Antrim Shale in Michigan

* Bakken Shale in Montana and North Dakota

* Barnett Shale in Texas

* Conasauga Shale in Alabama

* Eagle Ford Shale in South Texas

* Fayetteville Shale in Arkansas

* Floyd Shale in Mississippi and Alabama

* Gothic Shale (Paradox Basin) in Colorado

* Haynesville Shale on the Louisiana/Texas border

* Hermosa Shale in Utah

* Lewis Shale (San Juan Basin) in New Mexico

* Marcellus Shale under much of the US Northeast

* Mowry/Niobrara Shale in Colorado and Wyoming

* New Albany Shale between Illinois and Ohio

* Pearsall Shale in South Texas

* Woodford Shale in Oklahoma

There are also shale gas formations in other western states, including California.

Web Connections

Internet resources suggested by the Y. T. and Louise Lee Lum Library

American Institute of Minerals Appraisers--Minerals Valuation Resources http://www.mineralsappraisers.org/resources.html

American Petroleum Institute--Energy from Shale http://www.energyfromshale.org/resources

Interstate Oil and Gas Compact Commission http://www.iogcc.state, ok. us

US Energy Information Administration--Modern Shale Gas Development Primer http://www.netl.doe.gov/technologies/oil-gas/publications/EPreports/Shale-Gas-Primer-2009.pdf

US Geological Survey--Energy and Minerals, and Environmental Health http://www.usgs.gov/resources_envirohealth/default.asp

(1) Trevor R. Ellis, "The U.S. Mineral Property Valuation Patchwork of Regulations and Standards," in Mineral Property Valuation Proceedings--Papers Presented at Mining Millennium 2000 (Toronto: Canadian Institute of Mining, Metallurgy and Petroleum, March 8, 2000), 25-40, available at http://web.cim.org/mes/pdf/VALDAYTrevorEllis.pdf.

(2.) The International Valuation Standards Council has a committee addressing appraisal standards for the extractive industries. A discussion paper on issues related to development of the standards, "Valuations in the Extractive Industries," is available at http://www.ivsc.org/~ivscorg/sites/default/ files/Discussion%20Paper%20approved.pdf.

(3.) Rhett G. Campbeil, "Valuing Oil & Gas Assets in the Courtroom" (paper presented at conference of the American Institute of Business Law in conjunction with the Oklahoma Bar Review and Conference of Consumer Finance Law, February 7-8, 2002, Dallas, Texas), available at http://tkbpl.com/resources/ documents/Valuing%20Oil%20and%20Gas%20Assets%20in%20the%20courtroom%20(Campbell, %20R.).pdf.

(4.) Railroad Commission of Texas, "Frequently Asked Questions: Oil & Gas Exploration and Surface Ownership," http://www.rrc.state.tx.us/about/faqs/ SurfaceOwnerInfo.pdf.

(5.) Appraisal Institute, The Dictionary of Real Estate Appraisal, 5th ed. (Chicago: Appraisal Institute), 190.

(6.) Attorney Rhett G. Campbell, email to the authors, May 29, 2012.

(7.) Attorney Joe Kimball, email to the authors, September 9, 2011.

(8.) Lisa Vaughn, "Is the Mineral Estate Losing the Upper Hand in Texas?" Fort Worth Business Press, October 5, 2009.

(9.) For a comprehensive analysis of case law and statutes related to mineral estate dominance in most states, see Ned Stratton, "Surface Use and Damage Statutes: The Needed Balance in the Ongoing Battle between the Surface Owner and the Mineral Owner" (unpublished paper), http://www.nedstratton. com/media/Surface%200wner%20v%20Mineral%200wner.pdf.

(10.) Ibid., 17.

(11.) Attorney Justin Rammell, email to the authors, September 12, 2011.

(12.) Getty Oil Co. v. Jones, 470 S.W.2d 618, 622 (Tex. 1971).

(13.) Paul K. Asabere and Forrest E. Huffman, "The Value Discounts Associated with Historic Facade Easements," The Appraisal Journal (April 1994): 270-277.

(14.) N.D. Cent. Code [section] 38-11.1-01.

(15.) Andrew M. Miller, "A Journey Through Mineral Estate Dominance, the Accommodation Doctrine, and Beyond: Why Texas Is Ready to Take the Next Step with a Surface Damage Act," Houston Law Review 40, no. 2 (Summer 2003): 461-497, http://www.houstonlawreview.org/archive/downloads/40-2_pdf/ Millerg3.pdf.

(16.) Ibid., 473-477.

(17.) Rammell, email to the authors.

(18.) The owner of the mineral estate is the only one who can negotiate and grant a waiver of surface rights. When a landowner of the combined surface and mineral estate severs and sells the mineral estate, he or she can impose a surface waiver on the buyer of the minerals who will then lease to a producer subject to the surface waiver.

(19.) Although the concept of a fee simple determinable interest in the minerals is customary in Texas, some professionals take issue with anything less than a complete bundle of real property rights being designated as a fee simple interest. For further discussion, see Bearden Law Firm, "Texas Oil and Gas Property Rights" (unpublished law summary paper), http://www.beardenlawfirm.com/Texas%20Oil%20and%20Gas.pdf.

(20.) Standards Rule 1-2(e) of the Uniform Standards of Professional Appraisal Practice (USPAP) requires the appraiser to "identify the characteristics of the property that are relevant to the type and definition of value and intended use of the appraisal." Appraisal Standards Board, Uniform Standards of Professional Appraisal Practice, 2012-2013 ed. (Washington, DC: The Appraisal Foundation, 2012), Lines 510-511.

(21.) Uniform Appraisal Standards for Federal Land Acquisitions, Section D-11, "Valuation of Mineral Properties," http://www.justice.gov/enrd/land-ack/ Uniform-Appraisal-Standards.pdf.

(22.) USPAP Standards Rule 1-2(h), Lines 547-548; and Appraisal Standards Board, Advisory Opinion 28, "Scope of Work Decision, Performance and Disclosure," and Advisory Opinion 29, "An Acceptable Scope of Work," in USPAP Advisory Opinions, 2012-2013 ed. (Washington, DC: The Appraisal Foundation, 2012).

(23.) Campbell, email to the authors.

(24.) This subject is far more complex than space permits. For a thorough discussion of oil and gas appraisal, see Campbell, "Valuing Oil & Gas Assets in the Courtroom."

(25.) Uniform Appraisal Standards for Federal Land Acquisitions, 96.

(26.) MBTUs is the acronym for one million British thermal units. For natural gas pricing information, see US Energy information Administration, "Natural Gas Weekly Update," http://www.eia.gov/naturalgas/weekly/#jm-prices.

(27.) This example draws some of the facts from an actual assignment, but certain facts and procedures have been substantially abbreviated or changed to better demonstrate adjusting for the percentage of minerals conveyed and also to protect the confidentiality of the parties.

(28.) City of Austin v. Cannizzo, 267 S.W.2d 808 (Tex. 1954).

(29.) A thorough scope of work would include surveying other buyers, sellers, landowners, and related real estate professionals in the area, including petroleum land managers, to gain additional familiarity and a better sense of the market.

(30.) There is one exception, where Sale 4 receives a $100-per-acre positive adjustment because of its inferior access/location relative to the other comparable sales.

(31.) The mineral-only component of this sale gives an indication of the value of minerals when purchased separately, which is not the same as land with or without minerals. There is an advantage in owning minerals only, without the land, because the mineral estate is not subject of ad valorem taxes in Texas until the oil or gas is in production, while the land above is taxed. The $645 per mineral acre is good information, but it must be handled with care because this sale is materially different from a sale of land with or without minerals, which is the purpose of the appraisal.

(32.) Percent of canopy is a descriptive term used by veteran land appraisers to indication the degree to which the land is shaded by trees and tall brush.

(33.) For example, Campbell, "Valuing Oil & Gas Assets in the Courtroom."

(34.) Stratton, "Surface Use and Damage Statutes."

Joseph B. Lipscomb, PhD, MAI, is professor of finance and real estate in the Neeley School of Business at Texas Christian University, in Fort Worth, Texas. He holds a BS in architectural construction, an MBA, and a PhD in finance. He served as chairman of TCU's Finance Department from 1993 to 2001. He has been the director of the Luther King Capital Management Center for Financial Studies since its founding in 2001. In 2002, he served as president of the American Real Estate Society (ARES), the United States' largest academic organization dedicated to promoting research and education in real estate. His research has focused on real estate investment analysis, valuation issues, and developing a modern mortgage market in Mexico. He has published in The Appraisal Journal, Journal of Real Estate Research, Journal of Real Estate Literature, and Journal of Housing Research. Contact: j.lipscomb@tcu.edu

J. R. Kimball, MAI, is owner of J. R. Kimball, Inc., an appraisal firm in Fort Worth, Texas, offering the following services: appraisal review; consulting, easement analysis; eminent domain valuation and consulting; litigation and litigation support; and property management. His formal education includes Texas A&M University, BBA; Texas Christian University, ranch management program; Institute of Property Taxation; and Advanced Real Property Tax School. Other professional affiliations include the National Association of Realtors (NAR). Kimball has published a number of articles in The Appraisal Journal. Contact: jrkimballinc@yahoo.com
Table 1 Paired Sales Analysis Summary

Sales and Pairings       Indicated Mineral Value

Sale 1a minus Sale 2              $199
Sale 3 minus Sale 2               $341
Sale 4 minus Sale 2               $324
Sale 3 minus Sale 4               $392
Sale 5 minus Sale 2               $314
Weighted Average Value            $314

Table 2 Sales Adjustment Grid

                               Percent of
                                Minerals    Mineral Acres
Sale Number    Surface Acres    Conveyed      Conveyed

1a                  160           100%           160
2                   120             0%             0
3                   128           100%           128
4                   121            75%            91
5                   396            50%           198

Average             185

                                 Price Per
                                Acre of Land   Price Per Acre
                                with 100% of    of Land with
Sale Number    Price per Acre     Minerals      No Minerals

1a                 $2,544          $2,544          $2,231
2                  $2,345          $2,659          $2,345
3                  $2,686          $2,686          $2,372
4                  $2,588          $2,667          $2,353
5                  $2,502          $2,659          $2,345

Average                            $2,643          $2,329
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Author:Lipscomb, Joseph B.; Kimball, J.R.
Publication:Appraisal Journal
Article Type:Report
Geographic Code:1U7TX
Date:Sep 22, 2012
Words:7686
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