Traditionally, mineral rights and other oil and gas royalties have been regularly bought and sold by “brokers” who act as middlemen in most transactions. These brokers serve the important function of connecting capital (real end-buyers) with deals (sellers). However, brokers have introduced huge inefficiencies into the market, hurting both real buyers and mineral rights sellers.
When brokers control the course of the deal, both buyers and sellers are forced to rely on them for key information. In turn, this may allow a given broker to charge a large fee in the form of a commission. Big potential commissions in conjunction with minimal regulation, have opened the door to bad actors seeking to make a quick buck with deceptive practices.
Note: there are many honest and hardworking brokers in the market. We know several folks that operate with integrity and hope that posts like this can help them differentiate themselves.
Before we break down these deceptive practices, it might be helpful to look at the conditions that contributed to the rise of broker activity in the mineral space.
Why did the mineral market develop into a heavily “brokered” space?
The management team at Revere has collectively spent decades looking at several different energy markets. We have noticed that brokers tend to thrive in markets which are:
1. Fragmented: there are many different sellers of variously sized assets and many different buyers.
2. Illiquid: assets do not transact regularly.
3. Opaque (low transparency): buyers and sellers don’t always know what prices are being offered and paid.
Public stock markets, such as the New York Stock Exchange, offer good examples of situations where brokers take minimal commissions. These markets are liquid and transparent, making it hard for brokers to siphon value from buyers and sellers.
Real Estate offers a counter-example. Because the market is fragmented (many people own real estate) and illiquid, brokers can take large commissions for every transaction. However, at least Real Estate offers buyers and sellers some transparency. When a broker helps you sell your home — you get to see what the sale price was. With oil and gas royalties, that’s often not the case.
In the royalty business, all transactions are recorded with local courthouses. However, the actual clearing price of the transaction is seldom recorded. For a variety of historical reasons, the newly deeded asset can be recorded as a purchase for a token amount of cash (e.g. $10.00) plus other “good and valuable consideration” (see below example from a real courthouse document):
While the law varies from state to state, the law generally allows for the purchase price to be obscured in public record. Clearly, the founding fathers of this system prioritized privacy over transparency. To be fair, they probably didn’t anticipate the set of tactics that some brokers employ in the mineral and royalty market (more on that later).
To be clear, this lack of transparency also impacts buyers. As investors in the energy royalty space, we at Revere would love to have better visibility into the actual prices at which deals are being done.
So what does this all mean? Who cares if markets are fragmented, illiquid, and not transparent?
The problem begins with commissions which are detrimental to both sellers and buyers. Because of the nature of the royalty market, brokers tend to command 2–10% of the total transaction value as a fee. This can be particularly frustrating because many brokers do not add meaningful value to the sale process.
Real Estate agents are licensed professionals, royalty brokers are not. When a Real Estate agent helps you sell your home, they often provide significant services which can lead to higher prices for your home. The agent might help you “stage” the home with attractively arranged furniture, or spend their own money taking pictures and marketing the home. In the royalty space, it is sometimes the case that the broker doesn’t do anything other than pick up the phone and call a likely end-buyer. Unfortunately, brokerage commissions are difficult for the buyers and sellers to dispute because the broker may control the process. If a sellers want the deal, they may need to pay whatever commission the broker wants.
In order to reinforce this advantage, some brokers will withhold information about the seller’s asset. Many brokers do not know what information a real end-buyer will use to increase their offer value. They may know just enough to get the deal done. In some cases, this means the seller would have gotten a better deal if the buyer had better information. However, because the broker is incentivized to keep the buyer and seller from talking, the end-buyer is often forced to deal with incomplete information. Ask yourself — how much would you pay for a car if you couldn’t see it before you buy? What if you only had access to the production year, mileage, make and model? Most people don’t like risk and will underbid out of fear (e.g. “what if the car is scratched?”, etc.) in situations where they don’t have the full picture.
Simply put — the person with the best information will often be the one that is willing to pay the most for an asset.
High commissions and lack of information generally don’t help anyone except the broker. Unfortunately, it gets worse. In our next post, we’ll explore some of the devious practices currently being used by a subset of people in the brokerage business. These go far beyond simply taking a big commission.