Sparked by the immensely successful IPOs of Viper Energy Partners and PrairieSky Royalty Ltd., there has been a significant resurgence of interest in the oil and gas royalty space since this summer. According to various estimates (including TPH), the production from royalty and mineral interests in the US generates nearly $100 billion of annual cash flow that could exceed a staggering $1 trillion in value. Dave Pursell, Head of Securities at TPH, maintains that this cash flow stream is the single most important factor that has enabled the US Shale Boom. The private ownership of mineral rights aligns the interests of individuals and extraction companies, dispelling the “not in my backyard” mentality that has oil and gas development in countries where individual landowners do not directly benefit from resource exploitation.
This $1 trillion-plus market also represents the “size of the prize” that compelled more than 300 industry professionals and investors to attend the TPH Royalties Conference [earlier this month]. To kick off the conference, Maynard Holt, Co-President and Head of E&P Investment Banking at TPH, noted that the fundamental goal of the conference was to “bring together what is otherwise a somewhat disjointed market…to make sure that people know each other, make connections, understand who to call, and to get other people’s views.” Conference speakers included leaders from public and private Royalty MLPs and Royalty Trusts, institutional investors, private-equity sponsors, and attorneys. Some of the key takeaways included:
- Royalty interests are a unique asset class in that they provide non cost-bearing commodity exposure with significant long-term option value. In truth they are very sophisticated instruments.
- The market has historically been highly fractionated and illiquid. There is no industry-standard method for valuing a royalty.
- Increasing competition is driving up prices in the private market.
- Premium public market valuations of royalty vehicles such as Viper and PrairieSky have positively disrupted a Royalty Trusts market traditionally dominated by private players.
- Investor appetite for Royalty MLPs remains robust and newly formed entities are likely to go public in 2015.
- Large-cap E&P companies with large mineral holdings should increasingly look to bring forward NAV through the monetization of royalties.
Hugh Tucker, Partner at Baker Botts, discussed the various rights, obligations, and liabilities associated with different types of royalty interests (i.e. mineral interests, royalty interests, overriding royalty interests, net profits interests, production payments, and non-participating royalty interests.)
Dave Pursell, Head of Securities at TPH, shared his thoughts on the commodity price outlook, positing that “oil prices will fix themselves” after a short period of oversupply and tempered US production growth in the first half of 2015.
Joshua Davidson, Partner at Baker Botts, elaborated on the structural differences between Royalty Trusts and Royalty MLPs, highlighting the differences in cash distributions, IDRs, and tax features. In addition, he discussed key considerations for sponsors contemplating the formation of a public Royalty Trust or MLP, providing insight into how to choose the appropriate public vehicle based on the nature of the underlying assets, various tax consequences to the sponsor, the registration process, and potential marketing strategies.
Jack Rich, CIO at Abilene Christian University, and Mike Condon, CIO at Southern Methodist University, participated in a panel discussion on key investment and management considerations for owners of large mineral interest positions. Both panelists seemed to agree that stable distributions and long-term optionality make royalties an attractive asset class, despite the administrative challenges that come along with owning small interests in thousands of wells.
Travis Stice, CEO and President of Diamondback Energy and Viper Energy Partners, discussed the circumstances leading up to the formation of Viper Energy, as well as the opportunities and challenges associated with being the landmark IPO of mineral interests.
Christina Lopez, VP of Corporate Development at PrairieSky Royalty Ltd., discussed the nature of the royalties business in Canada, where the Government owns the majority of mineral rights. She highlighted the value PrairieSky places on the long-term optionality embedded in mineral interests, explaining how the company will restrict every lease it grants to a specific horizon.
The subsequent panel discussion touched on several distinct investment strategies and valuation frameworks being employed by investors in the private royalties market. Stuart Rexrode, CEO of BlueRock Energy Partners, discussed his fund’s strategy of purchasing term overrides to provide small operators with project financing. When asked about his approach to valuing non-producing mineral interest, Hardy Murchison, CEO of Encino Energy, indicated that he would buy interests at a valuation that yields a mid-teens rate of return assuming an appropriate development plan, but also that “the traditional rules of thumb have been thrown out the window” due to current premium public market valuations. Jesse Kimball, Managing Partner of Windswept Energy, described an investment strategy that entails backfilling operators in core areas identified via robust geological analyses. A key takeaway from the panel was that, in the words of Hardy Murchison, CEO of Encino Energy, “much like the non-op working interest acquisition business, over the last several years minerals, as an asset class, have matured a lot. There’s a lot more capital chasing them, a lot more visibly and from a lot more sources than there was a few years ago, yet the underlying business hasn’t really changed.”
Christopher Phillips, CEO of Phillips Energy Partners, shed light on unique opportunities and challenges associated with growing a minerals business with traditional private equity funding. He also highlighted their proprietary Royalty Management System developed to help efficiently manage and forecast their fractionated diversified mineral portfolio as well as to expedite the acquisition process.
Wyatt Hogan, President of Natural Resource Partners, discussed the company’s strategy of diversifying further into royalties and non-operated working interest in oil and gas and aggregates. Since 2011, Natural Resource Partners has invested ~$470 million in oil and gas royalties and non-operated working interest positions. This includes a $339mm acquisition of non-operated working interest in the Williston Basin that took place in October (TPH advised the seller, Kaiser-Francis Oil Company.)
Michael Rowe, Vice President of E&P Research at TPH, shared his thoughts on how the Street views Royalty MLPs. He indicated that while investors are still in the process of figuring out how to value royalty vehicles, they are beginning to recognize the valuation arbitrage and positive catalysts these vehicles provide.
Immediately following the conference, attendees were invited up to TPH’s offices to enjoy cocktails and hors d’oeuvres, and to tour TPH’s recently created conference space dubbed “The TPH Deal Center.”