Fort Pitt Capital can also help steer clients in the right direction if they need help navigating leases. “We are very used to putting together a team of professionals and wrapping around a client,” says Patten. The firm is also developing a seminar to educate landowners about shale planning issues.
Patten recommends that clients get bids from several energy companies and address property protection during the lease negotiation process. Important considerations include how close drills can be to a building, how the property is to be accessed and who is responsible for damaged drills. “A lot of folks focus on the dollar amount, but there are so many more details,” he says.
Patten knows what it’s like to be in their shoes. Several years ago, Royal Dutch Shell PLC, which owns or leases over 900,000 gross acres of Marcellus rights in the Appalachian Basin, approached his family about leasing out its working farm, which his grandfather used to run. His family belongs to a landowners group that negotiated a lease with Shell. Telling clients he is personally involved in the process has resonated well with them, he says.
Managing Expectations
Leases typically expire if companies fail to commence drilling within five years. “Landowners assume they’ll become millionaires overnight, but just because they have a lease and a five-year window doesn’t mean they will,” says Karabin of Clermont Wealth Strategies. He’s now starting to see a wave of renegotiations on wells that have been built but are yet to be tapped.
“It’s important to manage [client] expectations,” he says. “Maintenance issues and pipeline problems downstream can close the money spigot to landowners.” Like Patten, he emphasizes to them that shale wells have limited production lives.
The first year of production is typically the best from a revenue standpoint, says Karabin, who notes that year two natural gas production levels can range from 50% to 70% less than year one levels. Shale wells typically yield 80% of their production value in the first 10 years, and it could take another 30 to 40 years to get the remaining 20%, he says. He builds production decline curves to show clients their wells’ projected life.
General uncertainty of how long cash flow streams will last is a big challenge for clients impacted by Texas’s Eagle Ford Shale, says Harold Williams, president and CEO of Linscomb & Williams, a fee-based financial advisory firm that manages approximately $2 billion in assets. Fortunately, being based in Houston gives his team easy access to petroleum geologists when it requires an independent opinion on cash-flow longevity estimates, he says.
Linscomb & Williams uses a similar approach with shale clients as it does with those who come into wealth through other means. “It still gets down to tax planning, prudent investment policy, wealth transfer and those types of concerns,” he says.
In general, clients receiving sudden windfalls from Eagle Ford are inclined to use them to help improve their personal balance sheets, says George Williams, a senior vice president at Linscomb & Williams. This includes paying down debt and enhancing core capital dedicated to key objectives like financial independence planning for themselves or their children.
The firm helped a client form a family limited partnership to combine his Eagle Ford interests with interests held by extended family members. Combining their capital pool allows them to invest higher aggregate balances for the family as a whole, lowering overall fees. The family transferred the title of the minerals (not the land) to the FLP and then gifted partial interests in the FLP to a trust for their children. Since the FLP interests are illiquid, they are appraised at a discount from the true value of the minerals.