Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How the Ultra-Wealthy Use Mineral Rights for Royalty Income
Transcript
- Lucas: When you think about passive income for the ultra-wealthy, most people picture dividend stocks, real estate, or maybe a private equity stake. But there's a centuries-old asset class that still generates billions in royalty income every year, and it's hiding in plain sight — mineral rights. Luna: You mean owning the rights to what's under someone's land? Oil, gas, minerals? Lucas: Exactly. It's a bundle of property rights that can be separated from the surface itself. In the US, if you own the mineral rights under a tract of land, you can lease them to an oil and gas company and collect royalties — typically 12.5 to 25 percent of production revenue — without doing any operational work. Luna: So it's like being a silent partner in a drilling operation, but without any liability for what happens on the surface. Lucas: Right. And the wealthy have been doing this for generations. The Rockefellers, the Gettys, the Bass family of Texas — they all built or preserved significant wealth through mineral rights. Today, families like the Bass family still hold massive mineral portfolios. But the interesting thing is, it's not just for old oil dynasties anymore. There are now ways for high-net-worth individuals to get exposure without buying a whole ranch. Luna: Let's start with the basics. If I own a piece of land, do I automatically own the mineral rights underneath it? Lucas: Not necessarily. In the US, mineral rights can be severed from surface rights. So you could buy a ranch but the previous owner might have retained the minerals. That's actually a common source of conflict in oil-rich states like Texas, Oklahoma, and North Dakota. The surface owner might have a drilling rig on their land, but they get no royalty because they don't own the minerals. Luna: So how do the wealthy actually structure these deals? They're not just buying random tracts and hoping for a gusher. Lucas: No, it's far more systematic. Let me give you a concrete example. A wealthy family I know — let's call them the Harris family — acquired a 160-acre tract in the Permian Basin of West Texas back in 2018. They bought a 3 percent overriding royalty interest, meaning they get 3 percent of gross production revenue from any wells drilled on that land. The purchase price was about $2.4 million. Today, that interest generates roughly $240,000 a year in royalties — a 10 percent cash-on-cash yield before taxes. Luna: Ten percent yield? That's better than most dividend stocks and with commodity price upside. Lucas: Exactly. And the yield can fluctuate with oil prices, but the structure itself is attractive because it's tied to physical production, not corporate earnings. The Harris family doesn't have to worry about management decisions, capital expenditures, or operational risks. The operator — in this case, a mid-sized E&P company called Callon Petroleum — handles all of that. Luna: But what happens when the well runs dry? Depletion is a real risk. Lucas: That's the key risk. Oil and gas reserves are finite. A typical well in the Permian might produce for 20 to 30 years, but the bulk of the production comes in the first five to seven years. So the royalty income declines over time. That's why sophisticated mineral buyers look at the 'net present value' of future cash flows and model different depletion scenarios. They're essentially buying a bond with a declining coupon — but with commodity price upside. Luna: And there's the additional risk that the operator goes bankrupt or shuts in wells. How do they protect against that? Lucas: Due diligence on the operator is critical. The Harris family only buys mineral interests where the operator has a strong balance sheet and a track record of maintaining production. They also diversify across multiple basins — not just the Permian but also the Marcellus Shale in Pennsylvania and the Bakken in North Dakota. So if one operator cuts back, the others keep flowing. Luna: But what about the listener who doesn't have $2.4 million to buy a direct royalty interest? Is there a way to get exposure with, say, $200,000? Lucas: Absolutely. There are mineral-rights investment funds that pool capital from accredited investors to buy diversified portfolios of mineral interests. Some of these funds target net annualized returns of 8 to 12 percent after fees. Then there are publicly traded royalty trusts — like the Permian Basin Royalty Trust, ticker symbol P-B-T, or the Mesa Royalty Trust. These trade on the NYSE and pay monthly distributions based on oil and gas revenues. Luna: So it's a bit like owning an ETF that pays a variable dividend. But the tax treatment must be different, right? Lucas: That's where it gets interesting for the ultra-wealthy. Royalty income from mineral rights is generally taxed as ordinary income, but there's a significant deduction: 15 percent of gross income from oil and gas royalties is tax-free due to the 'percentage depletion' allowance. And if you hold the mineral rights for more than a year, any gain on sale is treated as long-term capital gains. But the real estate-planning benefit is the step-up in basis at death. Luna: The step-up in basis — that's huge. If you buy mineral rights for $2 million and they appreciate to $5 million, your heirs inherit them at the $5 million basis, so they can sell without paying capital gains tax on the appreciation. Lucas: Exactly. That's one reason wealthy families pass mineral rights down through trusts and LLCs. They can also contribute them to a charitable remainder trust, receive a tax deduction, and still collect income for life. The IRS treats mineral rights as a 'depletable asset,' which creates unique planning opportunities. Luna: Are there any pitfalls? I've heard stories about people inheriting mineral rights and then getting hit with massive tax bills because they didn't understand the passive activity loss rules. Lucas: That's a real risk. Mineral rights are considered a 'passive activity' under IRS rules, so losses can only offset passive income — not your salary or capital gains. Also, if you lease your rights and the operator drills a dry hole, you could have a loss that's unusable for years. And there's the 'net income limitation' on the depletion deduction. So it's not a set-it-and-forget-it asset. You need a good tax advisor who understands the rules. Luna: Speaking of advisors, how do you actually value mineral rights? It's not like looking up a stock price. Lucas: Valuation is part art, part science. The standard method is discounted cash flow analysis on the expected future production. You need a reserve report from a petroleum engineer, which estimates the remaining recoverable oil and gas. Then you apply a discount rate — typically 10 to 15 percent — to account for the risk of depletion and price volatility. The market for mineral rights is relatively illiquid, so spreads can be wide. That's why many wealthy families work with specialized brokers like Enverus or EnergyNet. Luna: So it's definitely not for the casual investor. But for someone with a high net worth and a long time horizon, it seems like a solid diversifier. Lucas: It really is. Mineral rights have a low correlation to stocks and bonds, they provide a hedge against inflation because commodity prices tend to rise with inflation, and they offer significant tax advantages. The Harris family treats their mineral portfolio as a core holding — about 15 percent of their net worth — alongside equities, real estate, and private equity. Luna: Fifteen percent sounds high. Most advisors recommend 5 to 10 percent in alternatives. Lucas: It is high, but the Harrises are comfortable because their mineral rights are in a basin with decades of proven reserves. They also have a clause in their lease that allows them to participate in any new wells without additional cost — that's called a 'back-in' provision. So they get upside without additional risk. Luna: That's smart. But let's bring it back to the listener who's intrigued but not a billionaire. What's the minimum check size for a direct mineral interest? Lucas: You can buy a small fractional interest for as little as $50,000 through online auctions like EnergyNet. But the due diligence is still on you — you need to review the lease, the operator's track record, and the reserve report. For most people, I'd recommend starting with a royalty trust or a fund, just to get comfortable with the cash flow mechanics before committing to a direct purchase. Luna: That sounds like a good approach. And along those lines, if you've found today's episode useful in thinking about your own portfolio, that's exactly the kind of conversation we try to have here. These shows stay ad-free thanks to listeners who appreciate them and choose to support. If you'd like to help keep that going, you can buy me a coffee dot com slash fexingo. Lucas: Yeah, we really appreciate that — it lets us keep doing deep dives on areas like this that don't get much mainstream coverage. So thank you if you've ever contributed. Luna: Absolutely. Now, back to mineral rights — one thing I find fascinating is how they interact with estate taxes. Can mineral rights actually reduce the taxable estate? Lucas: Yes, but it's nuanced. If you hold mineral rights through a properly structured family limited partnership or LLC, you can apply valuation discounts for lack of marketability and lack of control — typically 20 to 35 percent. So a $10 million mineral portfolio might be valued at $7 million for estate tax purposes. And because the minerals are a depletable asset, the estate can also take a depletion deduction on the inherited value. Luna: So it's really a multi-generational wealth transfer tool disguised as a natural resource investment. Lucas: Exactly. And that's why the ultra-wealthy have been quietly accumulating mineral rights for over a century. It's not flashy, it's not in the headlines, but it generates reliable cash flow with significant tax and estate planning benefits. In a world where yields are hard to find, that combination is increasingly attractive. Luna: Well, I'm not about to buy a ranch in West Texas anytime soon, but I'll definitely keep an eye on those royalty trusts. Thanks, Lucas. Lucas: My pleasure. And if you want to dig into the numbers, we'll have a link to the Permian Basin Royalty Trust's latest distribution history in the show notes. See you next time.