Recent talk of a shale bust has been heating up as energy companies, largely prompted by falling natural gas prices, scale back on drilling new wells and dangle fewer, more modest lease deals in front of landowners with oil and gas drilling rights. But this isn’t stopping some financial advisory firms from stepping up their efforts to try to capture more business in this niche.
In fact, Clermont Wealth Strategies—part of Fulton Financial Corp., a $16.6 billion Lancaster, Pa.-based holding company that has $6.3 billion in assets under management through its various wealth management and trust services entities—recently launched an oil, gas and mineral management practice to help landowners with such assets.
“We project this to be a multi-billion wealth management opportunity across the state of Pennsylvania and we’d like to capture our fair share of that,” says Steven Karabin, Clermont Wealth Strategies’ wealth and mineral asset advisor. Karabin, who became a financial advisor after retiring from a long career as an oil and gas engineer, previously built a landowner-focused wealth management practice at Merrill Lynch Wealth Management.
Most of Pennsylvania lies on top of the Marcellus Shale, a natural-gas-rich geological formation that also spans parts of West Virginia, Ohio and New York and small portions of Maryland and Virginia. Drilling activity in the Marcellus exploded several years ago with widespread adoption of hydraulic fracturing. The process, commonly referred to as fracking, involves drilling deep into underground rock formations and injecting them with highly pressurized liquid mixtures to extract oil and natural gas.
Clermont Wealth Strategies’ minerals practice—whose services include helping landowners understand and negotiate leases and figure out the value of their oil, gas and mineral interests—was created to provide added value to existing clients and to attract new clients. “It’s very difficult to approach landowners from a financial advisory mode,” says Karabin. “Many of these people never had wealth.”
The firm hopes that building a rapport and establishing credibility with these clients and showing them how they can build life-changing assets will put it in a better position to offer them wealth management, estate planning and other services, he says.
What about the shale bust concerns? Karabin acknowledges the leasing frenzy is over, but he largely attributes this to a temporary problem: maxed-out pipeline capacity that can’t carry more gas to market. In Pennsylvania, 1,500 to 2,000 Marcellus wells stand idle as they await pipelines, he says. He anticipates “tremendous activity” to resume once the pipeline network, which he says is undergoing billion-dollar construction projects, is built out in two to three years.
What’s more, he notes that so far drilling has only occurred in 3% of the drillable surface area in Pennsylvania’s portion of the Marcellus Shale. “It’s like we’re in inning one,” he says. Meanwhile, production figures are already hitting home runs.
In the first six months of 2013, Pennsylvania’s Marcellus Shale produced a record $5 billion worth of natural gas, says Karabin, citing data from the state’s Department of Environmental Protection. Based on the state’s minimum 12.5% royalty rate—a percentage of the gross production value of gas extracted from a well—landowners should have collectively received more than $600 million in royalties during this period, he notes.
Signing bonuses—acre-based, up-front lump sums that landowners receive before drilling begins—aren’t looking too shabby either. Although energy companies are no longer offering signing bonuses of $6,000 to $7,000 an acre, he still sees some attractive $2,000 to $3,000 an acre deals.
Help Wanted
Beyond the Marcellus, other states with substantial shale production include Texas, Louisiana, Oklahoma, Colorado, Arkansas, Michigan and North Dakota. Nationwide, an estimated 8.5 million private owners currently receive royalties on oil and gas interests, says Jerry R. Simmons, executive director of the National Association of Royalty Owners (NARO), a Tulsa, Okla.-based education/advocacy 501(c)(3) organization. The majority of these owners are individuals, although the figure does include some corporations.
In total, private owners were paid an estimated $22 billion in royalties in 2012, he says, citing a figure included in a report to be issued shortly by the Royalty Owners & Producers Educational (ROPE) Coalition where he is executive vice president. And many of them need help understanding and managing their oil and gas interests, he says.
Some families don’t even know what they own. “The call we get so often is, ‘Grandpa just died, there’s a shoebox of information,’” he says. He notes that NARO always holds a couple of financial planning sessions at its annual convention.
For its part, Pittsburgh-based Fort Pitt Capital Group, an independent, fee-only investment management firm that oversees approximately $1.3 billion of assets, got involved in this space after a few existing clients began talking to energy companies. Since then, it has also developed business through referrals from lawyers and landowner groups, and it’s trying to get more.
“Our major footprint is right in the middle of the Marcellus Shale boom,” says Daryl Patten, a financial advisor and vice president with Fort Pitt Capital. A handful of clients have signed contracts with energy companies and others are thinking about it, he says.
Patten is intrigued by the vast demographics of this market. A few months ago, he met with a wealthy West Virginia family that runs a few businesses and was about to lease some of its land for shale drilling. “On the other side of the coin is the farmer who struggles to keep the family land and is now getting a nice paycheck,” he says.
Patten emphasizes to clients the importance of putting a financial plan in place and not changing one’s lifestyle immediately. He also encourages them to focus on the fact that well production has a limited life span—often eight to 10 years, he says. “If you’re fortunate enough to get wells, you will have a nice income stream, but it’ll stop or trail off dramatically,” he says. “Don’t squander the windfall. Create a portfolio that can produce an income stream in perpetuity.”
One of his clients, a dairy farmer struggling to stay afloat, signed a lease for approximately 160 acres at about $3,500 per acre—or nearly $600,000 up front. “That can get him on his feet and stable and give him a great start,” says Patten.
The client plans to use this money to pay off some debt. His CPA and Patten are encouraging him to also prepay and deduct some business expenses this year. This could include replacing farm equipment; purchasing food for cattle, fertilizer and seed; and prepaying some insurance and utility expenses, says Patten. He also plans to set up Simplified Employee Pension (SEP) plans for the client and his wife, who have not previously worked with a financial planner.
Last year, one of Fort Pitt Capital’s clients received a check for roughly $150,000 for leasing out approximately 40 acres of her non-functioning working farm and placed the bulk of it directly into an after-tax account to invest it for long-term growth, he says.
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.
The bottom line: “This is an asset—this isn’t manna from heaven or mailbox money,” says Simmons of NARO. “You have to plan for it, and families work hard to get it.”