Minerals Investing Comes to the Fore
Recent deals challenge long-held assumptions that minerals are uncompetitive and non-scalable as minerals investing emerges after decades in the background.
By Gregory DL Morris
In early August 2018, Continental Resources Inc. and Franco-Nevada Corp., a precious metals royalties firm, formed a joint venture (JV) to acquire hydrocarbon mineral rights in Oklahoma’s Scoop and Stack plays. Franco- Nevada will contribute about $220 million for the acquisition of existing mineral rights owned by a Continental subsidiary. Franco-Nevada committed, subject to satisfaction of agreed-upon development thresholds, to spend up to $100 million per year over the next three years to ac- quire additional mineral rights. The existing mineral rights and others to be acquired later will be jointly held through the new company.
Revenues are expected to build as Continental ramps up development of its leasehold position. Franco-Nevada, based in Toronto, intends to fund its investment from cash on hand, partial use of its credit facilities and its projected future growing free cash flows. This new relationship will add to Franco-Nevada’s existing interests in the Scoop and Stack.
“In most cases people buy mineral rights blind, not knowing when, if ever, they will be developed,” said Jason O’Connell, the vice president of oil and gas for Franco- Nevada. “The idea here is to buy the mineral rights for sections where Continental plans to develop. Sure, in offering to acquire those rights we tip our hand a little and possibly pay more than the market price, but there is still a compelling value arbitrage that can be achieved.”
The terms of the transaction are complex, but essentially Franco-Nevada will pay 80% of the cost for the mineral rights being acquired, and then revenues are split 50:50 with Continental if the latter meets certain production targets.
“The transaction is hugely attractive to Continental,” O’Connell said. “They provide the information and they manage the program. We provide the bulk of the invesment, and they get half the revenue,” which for Continental is actually reduced outlay. Franco-Nevada is not new to energy, but has focused on gold royalties. In March 2015 at the bottom of the recent oil price decline, the company decided to increase its exposure to hydrocarbons.
“We are long-term investors,” O’Connell said. “We are not looking for profits in three to four years, but in 10, 20, 30 years. That is in contrast to the short-term investment objectives of private equity.” He also recognized Continental as a producer with experience in mineral rights. “They are already set up with the ability within the company to understand the complexities of mineral ownership. Most producers trying to replicate the idea would have to start from scratch. What they wanted was a strategic partner with long-term capital. That is us.”
BUSTING MINERAL MYTHS
The Hefner family has been involved in minerals investing for more than a century. And still, Robert Hefner V, President and CEO of Oklahoma City-based Hefner Energy Holdings LLC, said that as he grew up in the industry, conventional wisdom held that minerals were unable to compete with operated or non-operated working interest, and were not scalable.
“I never bothered to question those two assertions until about 2013, when I invested in some minerals in the Scoop at $100 [per barrel] oil. I noticed, even as oil prices collapsed to $40, my mineral investments were generating strong returns. Since the former was disproven, I then questioned the latter assumption that minerals were not scalable. “I started investing more in minerals and found that minerals are very scalable. Both of the two common beliefs about minerals were wrong,” Hefner said.
Given his love of history, Hefner has a theory as to why minerals suddenly seem to be on everyone’s mind in the last few years. “You always hesitate to say, ‘This time it’s different,’ but there are things about this cycle that were not present in previous industry cycles, notably horizontal drilling and hydraulic fracturing. The shale bonanza has meant massive capital programs, hundreds of millions [of dollars] for a single unit. That has significantly increased the velocity of the cash flow and the nature of CAPEX. Minerals investing is a CAPEX story.”
Having whetted his appetite busting myths about minerals, Hefner would like to dispense with one other, that investors could run out of things to buy. “There is a $10 billion unfunded market out there in Oklahoma. For all the work that has already been done—LongPoint, Brigham, Saxet, Expro and others—there has been $2 billion spent out of a potential for $12 billion or $13 billion,” he said. The minerals segment remains “highly inefficient and highly fragmented. So we say, yes, it’s good that more people are investing in minerals; the segment is still under-funded,” he said.
Exit strategies are a complex issue for minerals investors, Hefner noted. “Today, conditions are not favorable. The IPO market does not appear conducive and Wall Street has demonstrated a clear lack of understanding of the space, as evidenced by Kimbell Royalty Partners and Viper Minerals trading under the same metrics when they are very different companies with very different assets. We have a lot of work to do in educating the public markets.”
While many are currently dealing with those headaches, Hefner believes more yield-based investors will follow Franco-Nevada into the space and large pension funds will follow the major pension fund, Canada Pension Plan Investment Board, into the space to create more favorable conditions for exit in the future.
“Ultimately, mineral investments are the most flexible investments I’ve experienced. You don’t have to wait for an exit to make investor multiples —you can cash-flow multiples without an exit and wait to exit when market conditions are favorable,” Hefner said.