Property Taxes on Oil & Gas Interests are Based on Estimates
Property taxes on Oil & Gas interests in Texas are based on the ESTIMATES of the mineral reserves still in the ground. Nobody actually knows how much oil and gas is down there. The thing about estimates is that there are many ways to arrive at an estimate and nobody knows which is right. So, if you ask 10 experts to estimate how much oil and gas remains in the ground, every single expert will give a different number. THIS IS WHY OUR OIL &GAS TAX PROTESTS ARE SO POWERFUL. PERMIAN MINERAL TAX CONSULTANTS HAS EXPERTS TO ESTIMATE THE RESERVES AND HAS THE DATA TO BACK UP THOSE ESTIMATES. We also have the experience to show the appraiser why his or her estimates are too high.
Explanation of How Oil & Gas Interests are Taxed
Taxation of Oil & Gas Interests in Texas is governed by the Texas Property Tax Code. Section 11.01 of the Property Tax Code states that all Real Property and Tangible Personal Property within a taxing unit is appraised at its fair market value. Mineral Interests are classified as Real Property in Texas. Fair market value is basically the price at which a willing buyer would be willing to purchase a property with full knowledge of the use and restrictions of the property and neither the buyer nor seller is in a position to take advantage of the other.
Stated simply, for property tax purposes, the fair market value of a mineral interest is the price at which a willing buyer would pay for the mineral interest in an open market as of January 1 (the assessment date).
Although all Oil & Gas interests are taxable, it is difficult to value an interest in a lease that does not have a completed or producing well. Therefore, generally mineral interest holders do not receive appraisals unless and until a well is completed on the lease. After a producing well is drilled, the market value of your mineral interests is your net revenue interest’s percentage value of the total lease recoverable reserves to be produced in the future, discounted to present value. The market value of the future lease reserves are based on the appraiser’s projection of how much oil and gas will be produced from each lease using the State mandated Discounted Cash Flow appraisal method.
Note that the valuation of mineral interests IS NOT a tax on prior annual income. Instead, it is basically a tax on the estimate of how much oil and gas remains in the ground. A good rule of thumb is mineral interests are generally worth 3 or 4 times the prior year’s annual income. However, as production decreases, the valuation should decrease as well. Additionally, mineral interests are taxed separately from the surface interests.
Since 1926, every producing well in every county in Texas has been assessed using the same methodology mandated by the state. The Texas Comptroller requires recoverable reserves for producing mineral interests be calculated using the Discounted Cash Flow (DCF) approach for taxation purposes. This is actually a reasonable method for oil and gas leases because income can be reasonably projected through analysis based on prior history.
The four basic parameters common to all producing oil and gas properties in the DCF valuation:
1) Production Profile: Consists of two components- (A) Start Rate & (B) Production Decline
A) Start Rate of production – The appraiser’s determination of a relevant average daily barrel rate for oil and/or an average daily MCF gas rate from prior calendar year’s actual production up to Jan 1. This rate can be selected from any time period of the prior year, but must be adjusted for that time period.
B) Production Decline – The appraiser’s determination of each individual lease’s future year/s decline rate/s for oil and/or gas production to be used in the current year’s appraisal. Source: The decline rate is selected using advanced production plotting and projecting software. Usually, projections of future production are projected to decline into the future;
Note: Permian Mineral Tax Consultants uses stat-of-the-art production plotting and projecting software as part of the analysis which sets our analysis apart from others. Most agents to do not have this advanced software because they do not have the expertise necessary to use the software and because it is expensive. This is also the reason our protests are far more successful than others in the industry.
2) Price –For the DCF valuation, the price is the monthly average price for the preceding calendar year multiplied by Comptroller’s Market Condition Factor (CMCF) for the first year’s price. The escalation/deescalation of pricing after the first year is now based on the Comptroller’s model. State Severance taxes previously deducted from your income are deducted from the gross price to arrive at the net appraisal price;
3) Operating Expense (LOE) – The operator’s anticipated annually recurring cost to operate the lease.
4) Discount Rate – The overall rate consists of two parts: (1) a consideration for the cost of money as of January 1 and (2) the risk of the property itself (dictated by production rates and declines in addition to technical, economic and political influences). The mid-year discount rate factor of the overall discount rate is used to bring future income back to present worth for each future year of the appraisal.
Needless to say, the calculations are very complex. I won’t go into the exact formulas used for the Discounted Cash Flow analysis, but if you are interested, you can view the Texas Comptroller’s Manual for Discounting Oil & Gas Income.