Assessing a proper value for oil rights is a crucial part of being successful in OilFinancier.

If you bid too high for oil rights, you will not only have oil rights to which will be difficult to recover your investment, but you will have also squandered cash that could have been invested better elsewhere. You could be sitting on the sideline waiting for others to make deals for your oil rights on their terms, not yours, because you spent too much money on oil rights!

When you enter negotiations for drilling a well, you should put some value on the oil right, whether you own that right or not. In essence, the owner of the right should get good value for the property and the financiers should have a deal that makes sense for the money they are putting into the well.

If the owner of the oil rights paid a high premium for these rights some time ago—and wants too much to recover that money—the other financiers may just find other places to invest. On the other hand, if the owner paid a low price for the rights and circumstances are that it’s very likely to now have oil, the owner should evaluate that right on its ability to make money, not the low price paid for it.

Another factor that plays into evaluating oil rights is time. When a financier buys an oil right, that money is gone. By putting that money down now, the financier might not see any rewards for another 50 to 150 OF days—or perhaps never. The time component, from the purchase of the right to the actual drilling of the well, needs to be considered.

This example shows how to approach evaluating oil rights. Other acceptable ways of assessing value exist, and you are certainly free to use your own methods. If your OilFinancier share price goes up in the long term, you are doing something right.

I own an oil right that is next to an intermediate well. The chance of success for another intermediate well on my right is 80%. A dealmaker is approaching me to drill on my oil right.

To keep this analysis simple, we’ll assume that the dealmaker is investing the entire $200,000—and I am only contributing the oil right. How much of the total cut of revenue should I take for my oil right?

To evaluate my oil right, I first need to consider my needs. My historical discount rate has been 1.2%. Any deal we make should have a profit for me using this discount rate.

When I do the analysis for the partnership, I get an ENPV of $158,000. This $158,000 represents the negotiating room of this deal. If I push my potential partner to the edge, I could conceivably get most of this ENPV from him, but this is the maximum. If I push any more, I should not be surprised that he walks away.

This calculation is based on the assumption that he has the same discount rate as I have. If his discount rate is 1.7%, the ENPV comes to $140,000. If I try to get $145,000 ENPV for my oil right, he should walk away—even though $145,000 seems to give him enough room to make a deal at my assessment of $158,000. Likewise, if his discount rate is lower than mine, I could ask for more than $158,000 and we could still make a deal.

But let’s assume that he is using a similar discount rate as I am. Now I need to determine my maximum cut of the total revenue I can take. I go back to my NPV spreadsheets using the intermediate well analysis. I put $0 as my drilling cost because I am not contributing any finances to this deal. I then experiment with the initial cash-flow value—at 80% success rate—until I get $158,000 of ENPV. After a little fiddling, I find my ENPV reaches $158,000 when my oil right should get $3,500 of the initial cash flow—or 44% of the revenue. Whether I paid $300 or $30,000 for this oil right is irrelevant.

This 44% sounds like a lot just for the oil right. So let’s check the analysis from the financier’s perspective. He invests $200,000 to get 56% of the revenue of this project with an 80% success rate at a discount rate of 1.2%. When I put his numbers into the spreadsheet, he gets an ENPV of $1,000, which is essentially nothing. There really is no incentive for him to make this deal with a 56/44 split. I know I have to lower my expectation from 44%: the question is how much?

When I do the analysis with a 60/40 split, I get an ENPV of $143,000 for myself and an ENPV of $14,000 for him (notice the two numbers always add up pretty close to $158,000). Because he now has a significantly positive ENPV, he should theorectically take this deal. He certainly cannot earn this $14,000 without my oil right. But, as you know, sometimes theories don’t work out—which means we need to do another analysis.

The financier and I could not make a deal with me taking a 44% cut for my oil right. With a 60/40 split there is only a little profit for him. He proposes that I get 32%, which means he gets 68% of the revenue for his $200,000 investment.

Although I’m sure I can get 40% with a deal from him or someone else, it’s very much a case of a bird in the hand is worth two in the bush. My oil right may still be very attractive to other financiers, but it may take some time before I can make a deal with them. Should I take the 32% offer right now or should I wait about 20 OF days for a deal that gives me 40%?

When I do the numbers, the 32% offer gives me $114,000 of ENPV. When I plug in 40%—with the 20-day delay—I get $118,000 of ENPV. The numbers are telling me that I should wait for a better deal than take the 32% right now. But two numbers are pretty close, which tells me I should not wait much past 20 days to make the deal with 40%. If I can’t see a deal coming within this time, I should take the 32% deal.

The trick is estimating the delay. If the financiers are occupied with filling in shallow and deep fields, I might have to wait 50 days to find a deal because these plays are better prospects than intermediate plays. When I plug in the 50-day delay with a 40% cut, I get an ENPV of $81,000. In this case, I should take that 32% to get my asset working for me right now. After all, $114,000 of ENPV (32% cut, no delay) is much better than $81,000 (40% cut, 50-day delay).

But if the intermediate play looks like the only game in town for this time in OF seminar, I should be able to bring in much of that $158,000 for myself. It’s a matter of recognizing where the opportunity costs lie for all financiers.

When you first start an OilFinanicer seminar, you probably won’t have all the skills in place to properly evaluate the first oil rights for auction. My financial analysis tells me that value of the oil rights in the early part of the game are about $4,000 each. At this bid, you should be able to make money over the long term—even though more than half of these rights you buy with this bid will have no oil under them. Those financiers who spend more than $10,000 in the early part of the seminar are definitely crazy!

As you gain more experience, you can fine-tune the oil rights evaluation of exploratory and development oil rights. You will have lots of different scenarios to analyze.

Evaluating oil rights is an important part of OilFinancier. Successful tycoons will know how to look at a deal from the perspectives of the owners of the oil rights, potential investors with lower discount rates, and potential investors with higher discount rates. In the meantime, they also work out a deal that provides a fair return for their own investment in an ever-changing environment. This means you’ll have to evaluate lots of different opportunities.

Where else can you get such training without having to put up real money—except in an OilFinancier seminar?