Doug Houser: From Rea & Associates Studio, this is unsuitable, a management and financial services podcast for entrepreneurs, tenured business leaders, and others who are ready to look beyond the suit and tie culture for meaningful, measurable results.
I’m Doug Houser.
Oil and gas activity in the Utica and Marcellus shale formations continues to generate a lot of buzz, and if you are a landowner in these particular regions, chances are good that you’ve already been sought after for your mineral rights. On today’s show, Scott Moyer, a principal in Rea’s Zanesville office and founder of the Four Pillars Strategy for Landowners tells us what’s going on in the oil and gas space these days. He’s going to tell us more about the wealth management and asset protection options available to land owners in the Utica and Marcellus shale regions. Welcome, Scott.
Scott Moyer: Thanks Doug. I’m happy to be here.
Doug: Good to have you here. So four pillars. What does that mean? It sounds like the building blocks of The Browns over the last 15 years. That scares me a little bit. Hopefully it’s a little more successful than that’s been.
Scott: They’ve needed more pillars, so yes. So the four pillars that we’re referring to today in the oil and gas industry is income taxes, asset protection, transfer of wealth, and royalty auditing. All play off each other and all have to do with, like you hit on, the horizontal drilling going on in southeastern Ohio, western PA, and northeastern West Virginia. There’s a lot of things going on over there. A lot of people have come into some wealth in the oil and gas field, and they need our guidance, and that has been the case since 2010.
Doug: Okay, so are folks being taken advantage of? What’s the genesis behind the four pillars here? Are we trying to just provide, obviously, additional guidance and all of that? How does it-
Scott: Yeah, so at first, when I was first introduced to this area by Merrill Lynch, the Moyer Group, they were doing seminars down in this area. We were seeing land men who represent oil and gas companies leasing folks on these rights, the Marcellus and the Utica rights, for pennies on the dollar, considerably lower than what folks are commanding today.
Scott: So we recognized, okay, are these folks going to need us just to do income tax compliance? Simple 1040 filing? What can we do to help these folks, not only with their income tax compliance, because this revenue is interesting and it is unique, but from there, from the income tax compliance, how can we help them protect this asset, this golden goose that lays the golden egg?
Scott: How do we help them transfer their wealth to the next generation, potentially while they’re living or unfortunately when they pass away? And then last but not least, with royalty auditing, how do we make sure they’re being paid correctly?
Scott: Because when they start getting royalties, the checks look like Egyptian hieroglyphics. They’re very hard to read.
Doug: Oh, okay. And I’m sure that’s on purpose by those that are paying the royalties, to try to make it more complex for them to understand.
Scott: Yes, it’s a complex industry. There’s three different products that are being produced in most cases. And so it is tough for these companies to display it in a simplified manner. So it’s difficult to understand.
Doug: Sure. So when you talk about the four pillars and you explain that to folks who have an opportunity in the oil and gas space, how do you lay that out for them beyond what you’ve talked about already? But to explain, okay, this is the start, but where do we … the journey is really the important part. Is that fair to say?
Scott: Yeah. And the pillars are very easy to work through with the land owners. We start with pillar number one, income taxes. These folks are going to have an opportunity, if they already haven’t, they’re going to get a lease bonus. So when they sign a lease with an oil and gas company, they’re going to get paid a sum of money multiplied by their ownership acreage.
Scott: And that’s going to get taxed. And so what we do with that is we make sure that we prepare for that. We do year end planning for them. The new tax law has changed some of our methodology and planning, but there are still mechanisms to save income taxes if you get paid a lump sum lease bonus up front.
Scott: The other is pipeline easements. There was a wave about two to three years ago of pipeline easements going across people’s properties. Folks would come to the door and they would knock on the landowner’s door and they would state that, “Hey, you want a lot of this classified as damages because those aren’t taxable.” Well that’s incorrect.
Doug: Oh, okay.
Scott: And they were led astray on that. So, we coach these folks that if they’re approached with a pipeline easement, they need to get us involved and they need to get an attorney involved, an experienced oil and gas attorney, to make sure that they structure that contract properly. And then the income tax compliance on pipeline easements. It’s tough.
Doug: Is it complex?
Scott: It’s complex.
Scott: The third and final bucket is, there’s just the royalty payment. That’s when production starts, drilling has occurred. Fracking has occurred. And the well is in production, and the folks who own the ground and they lease the ground, the mineral rights, excuse me, they start to get paid a royalty.
Scott: And it’s based on a percentage of the production.
Doug: Okay. So you try to sit down and help them plan ahead and say, “Okay, here’s how we’re going to deal with this,” and help balance out cash considerations. As you said, wealth planning, transfer of wealth, all those types of things.
Scott: Yeah. Because a lot of people, they’ll rush to pay their income taxes right away on the money. Or they’ll think that if they build a barn or they buy a tractor that they didn’t necessarily need, they think it’s a dollar for dollar tax savings. And I debunk those myths. And that’s really the income tax pillar.
The other two pillars really play off each other. And then of course we have the fourth pillar, royalty auditing, but the middle two pillars, asset protection and transfer of wealth, that has to do with really what you’re talking about, Doug, and that’s the family approach. This asset is very important to the family. Maybe it wasn’t 25 years ago, maybe they didn’t know, but it is now. So asset protection, we’re working with our oil and gas attorney to structure family LLCs, limited liability companies. We’re breaking out the mineral rights from the surface and we’re deeding them over to the mineral rights LLCs.
Doug: Interesting. Okay.
Scott: And husband and wife usually own 50% out of the gate. It’s taxed as a partnership. We think that protects that asset from a legal liability perspective.
Doug: Really segregates it from everything else, basically.
Scott: Correct. God forbid something occurred on the farm land and the folks were sued, per the lawyer that we work with, we think that segregating the minerals out of your personal name further protects you.
Scott: And then from there, inside that family LLC, it’s fairly easy to transfer wealth or gift units of that LLC instead of having to chop up mineral rights at the courthouse, they’re all housed underneath one LLC with, let’s just say, a thousand units of ownership. The transfer of wealth pillar allows the family to gift those units to children or grandchildren while they live. Or they can spell it out in their will or estate state plan to go to the children when they pass.
Doug: That’s awesome. A much more comprehensive thought process than just sort of, “Hey, I’ve found this asset all of a sudden, or discovered this asset is worth something, and now what do I do?”
Scott: Correct. And where it really comes into play is over time in these areas, people have purchased farm land that maybe is not contiguous.
Scott: So we have minerals over here, we have minerals over there, and the LLC, there’s a title search done by the attorney and it’s pulled all together.
Scott: And then that way it’s paid underneath one roof, the LLC roof. And it’s easy to account for.
Doug: Okay, that’s fantastic. So it’s a great strategy. What are some of the risks you’re seeing on a macro level in the industry? I mean, you see the fluctuation in oil and gas prices, and how do you factor in, obviously nobody can predict the market 10 years from now, but how do you factor in some of these macro issues for folks?
Scott: Yes. So, we do a … when when gifting occurs and children are brought in or just evaluation of minerals is done by a petroleum engineer colleague of ours, we are able to see 30 years into the future on what the reserves could produce.
Scott: It’s very, it’s a great report. I highly recommend it. But it’s interesting, you bring up a great point. A lot of people focus on the price per barrel of oil, and it is very important, it controls economics sometimes. But what we’re dealing with, with these formations, is more dry gas and a combination of wet gas where the wet gas is called condensate. And they are stripping out the hydrocarbons, and they’re sending them to a plant that eventually those items are made into plastics.
Doug: Okay. Interesting.
Scott: And so everybody monitors the price per barrel of oil all the time. All the time. But I continue to school these folks that they need to follow the price per MCF of natural gas. Because that is the main thing that’s being produced from these formations.
Doug: Okay. That’s good to know. Yeah, absolutely. Now I’ve read some some stuff too that there’s, particularly in the Appalachian region, there’s capacity constraint with midstream production. So there’s facilities under construction or in planning stages. Will that help production in your view? Or where does that factor in?
Scott: Definitely. The leaseholds back in 2008, 09, and 10, they far outpaced the infrastructure that you just hit on.
Scott: And the infrastructure is key, especially with this product being predominantly natural gas. We need the pipelines to move that product. We need compressor stations to compress the product and get it to the plants, and that stuff was not ready yet. And so folks were drilling in 11, 12, 13, and our infrastructure wasn’t quite there yet. so we’ve got this glut of natural gas or it was being burned off, and now it’s finally starting to catch up.
Scott: And that’s why I hit on that pipeline easement part in that first pillar of income taxes. Because pipelines are, in my opinion, still in their infancy stage.
Scott: There’s going to be a lot more pipelines built potentially, and because these formations are producing a ton of natural gas.
Doug: Okay. Now when you talk about then the fourth pillar, the royalty audit, is that something, do we do that? Is that outsourced to other experts? How does that work exactly?
Scott: Yeah. Rea & Associates does that. We do it in two different buckets, royalty monitoring or a full fledged royalty audit. Royalty monitoring we really just do from our desks, and we take a look at at the volumes that are being produced by said wells and we compare that to what’s being reported to the government entity, either the Ohio Department of Natural Resources, Pennsylvania Natural Resources or West Virginia.
Scott: And we compare those volumes. We take a look at the decimal interest that determines how the landowner is paid. We make sure that that’s correct.
Doug: Do you see a lot of inconsistencies with this stuff? I mean, is there-
Scott: Yeah, there are. A lot of it has to do with chain of title not being correct out of the chute. A lot of it can be simple arithmetic. The decimal interest for a landowner goes eight places after the decimal point.
Scott: So it’s interesting.
Scott: And then from there we move to price. Is the price per MCF of natural gas or the price per barrel of oil, is that comparable to market?
Scott: And if we see glaring issues through our desk, through our royalty monitoring from our desk, we recommend to the landowner that they move forward with a royalty audit. And that’s where we get under the hood and we take a look at the records of the oil and gas company because they’re like any other business. They’re getting paid, and then they’re paying somebody else to move the product to the sales point. And we just, royalty auditing makes sure that the land owner is being paid properly.
Doug: And the landowner has the right to get access to the that that information.
Scott: Yes, some leases spell that out. Some do not. Rea & Associates, we always prefer to engage with an oil and gas attorney, and then the oil and gas attorney engages with the landowner. That provides client attorney privilege with us and the attorney. And also when we get under the hood, it allows … we can’t interpret contracts as CPAs, so it allows us to be engaged by the attorney already. Then we can just involve them directly to interpret some contracts, either sales contracts or expense contracts or the lease altogether.
Doug: Wow. Pays to have the right expertise, obviously. A lot more complexity behind it than I would have certainly thought up front.
Scott: Yeah, there’s a lot. It’s highly specialized. Rea & Associates has invested a lot time and energy into this. We’ve developed this four pillars approach, and we think it serves the land owner to the best of our abilities.
Doug: All right, that’s great. So if I think about the four pillars, is there one spot where you see more neglect or that gets ignored or less emphasis than it should?
Scott: I think it’s the third pillar. Transfer of wealth.
Scott: There’s not a lot of gifting done to children yet. I’m seeing that the parents who have worked hard over their lifetime to pay for that farm land that they bought way back when, they’re wanting to enjoy the fruits of their labor based on the royalties from those mineral rights. There’s not a whole lot of gifting to children while they’re living, but there is some. But if I had to identify a pillar where I’m spending the least amount of time, it would be the transfer of wealth.
Now, as we grow older and folks pass away, there’ll be a lot of time needing to be spent in that pillar. But right now fortunately we’re not having to spend a lot in that pillar.
Doug: Yeah. But especially as you said, it just made me think when you, there’s 30 years or whatever of reserves there. So there’s a lot of forward thinking and planning that has to go in place. It’s not like this is a one or two year deal and then forget it.
Scott: You made a great point there. A lot of people ask those questions when we meet and I can’t predict the future. I work close with a close petroleum engineer friend, and they do studies, but again, they can’t fully predict the future either.
Scott: But what you can go by is, look at the investment these companies are making in our area. They’re not just making this overnight investment and then going to pull out in two years. They’ve done their homework, they’re going to continue to improve technology, and they’re going to be here for a while. And so we noticed at Rea & Associates that we need to be prepared for this and we need to help these folks. We have a Barnesville satellite office, Barnesville Ohio, that allows us to be closer to this play. It’s just, it’s been very rewarding and I think all of our clients have enjoyed working with us on these pillars.
Doug: Yeah, that’s great. I think that’s a great way, and a simple way, for people to understand it. From a construction perspective, that’s always my thought process like, “Oh, I can understand what a pillar means and if I’ve got one that’s not in place or that’s weak, then look out, my house of cards is coming down.”.
Doug: That’s great stuff. So, speaking of pillars and we started off with the Browns, what’s your outlook this year? You all in on Baker and the boys?
Scott: 10 and six and they get in the playoffs. Win the north and get in the playoffs.
Scott: Maybe not a buy, but I think they get in there.
Doug: I like it. They’ve got a lot of talent, so we’ll hope to see if they can make it happen.
Scott: Hopefully they can control all those egos. So we’ll see.
Doug: Yeah, yeah. We’ll see. We’ll see. I guess that’s a good problem for them to have for once.
Doug: Yeah. Awesome. Well thanks, Scott.
Scott: Thank you.
Doug: Appreciate you being here.
Scott: Thanks a lot.
Doug: And if you want to learn more about the four pillars strategy for land owners or to hear previous episodes of Unsuitable, visit our podcast page at www.reacpa.com/podcast. Thanks for listening to this week’s show. You can subscribe to Unsuitable on iTunes or wherever you like to get your podcasts, including YouTube. And while you’re there, please leave us a review. You can also write to us at firstname.lastname@example.org. I’m Doug Houser. Join us next week for another Unsuitable interview from an industry professional.
Disclaimer: The views expressed on Unsuitable on Rea Radio are our own, and do not necessarily reflect the views of Rea & Associates. The podcast is for informational and educational purposes only and is not intended to replace the professional advice you would receive elsewhere. Consult with a trusted advisor about your unique situation so they can expertly guide you to the best solution for your specific circumstance.