|Shares Out. (in M):||221||P/E||0||0|
|Market Cap (in $M):||1,292||P/FCF||0||0|
|Net Debt (in $M):||170||EBIT||0||0|
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Black Stone Minerals has garnered a lot of conversation on VIC in recent months and has been written up twice by jso1123 and Kruger. Those write ups covered the subordinated unit structure (now converted), relative valuation, and probabilistic view on distribution outcomes in detail. My hope is that this post is additive to the conversation.
Black Stone Minerals is one of the largest owners of oil and natural gas mineral and royalty interests in the United States. They own more than twenty million gross mineral and royalty acres, which are perpetual non-cost-bearing assets located across forty-one states and sixty-two onshore basins. Many of these interests are in active resource plays including the Bakken/Three Forks, Eagle Ford, Haynesville/Bossier, and Wolfcamp/Spraberry/Bone Spring. The breadth of the mineral estate, long lived nature of the assets, and active resource management exposes Black Stone Minerals to growth from new and existing plays without the need to invest additional capital. Tom Carter, the CEO of Black Stone Minerals, owns twelve percent of outstanding common shares and has over forty years of experience in the oil and gas industry.
In 1876, W.T. Carter & Bro, the predecessor of Black Stone Minerals, was founded in Southeast Texas as a family operated lumber company. After nearly a century of profitable operations, in the 1960’s, the family began to divest the timber and lumber properties but retained the subsurface mineral interests in order to pivot towards oil and gas exploration. Black Stone Minerals was formed to develop the prospective acreage throughout the 1980’s, which ultimately led to the discovery of the prolific Double A Wells Field in East Texas. In 1992, Black Stone Minerals acquired the mineral estate of the Kirby Lumber Company which marked its first acquisition of mineral interests and expanded its existing core asset base in East Texas. Over the next several years, Black Stone Minerals shifted its focus away from exploration toward the acquisition of mineral and royalty interests, embarking on an acquisition campaign that resulted in approximately $100 million of transactions. Eventually, Black Stone Minerals began managing institutionally backed private investment funds. The partnership and its fund affiliates invested approximately $1.2 billion in over twenty transactions between 2002 and 2010. After many years of success, Black Stone Minerals decided to discontinue the private fund business and instead purchase all future transactions directly. Private fund interests were offered an exchange of their fund ownership for cash or equity, and in a robust display of confidence, over ninety percent of limited partners elected to receive equity. In 2015, Black Stone Minerals completed its Initial Public Offering becoming the largest publicly traded mineral and royalty company in the United States.
Introduction to Mineral Interests
Mineral interests are real property interests that are perpetual and grant ownership to all the oil and natural gas lying below the surface of a property, as well as the right to explore, drill and produce on that property. Mineral owners typically grant leases to operators under an initial three‑year term in exchange for an upfront cash payment known as a lease bonus and a royalty interest entitling the owner to a cost‑free percentage of production (usually ranging from fifteen to twenty-five percent). The lease can be extended beyond the initial term with continuous operating activities, but when production or drilling ceases on the leased property, the lease is terminated and all mineral rights revert back to the mineral owner who can then lease the exploration and development rights to another party. The market for mineral interests in the United States is large, remains highly fragmented, and is essential to the ongoing operations of energy majors and independents alike. Global consumption of fossil fuels, particularly natural gas, is expected to grow for several decades and mineral interests occupy an enviable position in the industry value chain. Compared to upstream operators, mineral interests are less sensitive to commodity prices, do not require capital outlay for production growth, and are net beneficiaries of technological innovation. Upstream operators often use debt to fund drilling programs which are necessary for acreage capture, to achieve scale, and to replace declining base production. The result are highly leveraged capital structures backed by assets tethered to commodity prices - not exactly a recipe for success. On the other hand, midstream assets share many attractive features with mineral interests. Fee based payments and minimum volume commitments provide stable cash flows that are less sensitive to commodity pricing, and regulatory barriers to entry make competitive dynamics less severe. However, midstream projects are capital intensive, have predetermined growth profiles, and require ongoing maintenance. Mineral ownership uniquely offers both downside protection and the potential for growth without capital. In actuality, three distinct assets comprise Black Stone Minerals’ portfolio: mineral interests, non participating royalty interests (NPRIs), and overriding royalty interests (ORRIs). Like mineral interests, NPRIs represent the right, which is perpetual, to receive a cost-free percentage of production from a specified property. NPRIs, however, do not have the associated right to structure and execute a lease or to receive a lease bonus. They are in effect minority interests. ORRIs are royalty interests that burden a lease and represent the right to receive a cost-free percentage of production. These are not perpetual assets but remain in effect until the associated lease expires. Collectively, Black Stone Minerals owns 7.2 million net mineral interest acres, 340 thousand NPRI net acres, and 240 thousand ORRI net acres. This expansive acreage position is diversified by basin, commodity, and has a healthy mix of PDP and non-PDP assets. At present, over seventy percent of Black Stone Minerals acreage position is unleased.
Technology & Innovation - The Shale Revolution
The United States is a legal anomaly in that it is one of the only countries in the world that recognizes the right of individuals to own subsurface minerals interests. Elsewhere, mineral interests belong to the government which has created a profound structural advantage for the domestic oil and gas industry. Since the nineteenth century, oil and gas entrepreneurs in the United States have intensively delineated geologic formations with the support of private capital markets and a favorable regulatory environment. This cultivated an abundance of geologic expertise, promoted innovation, and necessitated the development of a large network of midstream infrastructure. In addition, more recently, advancements in horizontal drilling and hydraulic fracturing have made unconventional resources, such as those found in shale and tight sand formations, increasingly economically viable. Recall that shale formations are typically the source rock for conventional reservoirs. Over millennia, and with requisite porosity, hydrocarbons within shale have migrated towards lower pressure through other formations until accumulating beneath a geologic trap. This impermeable layer of rock stops the free flow of hydrocarbons and produces a conventional reservoir, which has been the target of oil and gas operators over the prior century. Unconventional drilling, however, exploits shale as both the source rock and the geologic trap. This has led to unprecedented leaps in well productivity and has transformed the United States into a leading global producer of oil and gas. Notably, this success is unlikely to be replicated abroad. Shale deposits are often large geologic formations and require extensive seismic mapping and appraisal drilling to locate the core of a play. The United States boasts over one hundred years of drilling data across more than sixty onshore basins, an asset that would be challenging to replicate. Moreover, resources must be accessible and in many countries shale deposits are located in densely populated or mountainous areas. Finally, sufficient infrastructure capacity must be present to transport resources which does not exist in countries without a history of oil and gas exploration. Altogether, these challenges are exacerbated by government involvement which is often plagued by corruption and inefficiency. In the United States, horizontal shale wells now account for seventy percent of oil and gas production, which is up more than six fold over the last decade. Estimated Ultimate Recovery (EUR) per well has increased at a remarkable pace as operators iterate on completion designs and develop innovative technologies aimed at enhancing recovery. Unfortunately, operators are often caught, as Warren Buffett says, “standing on tiptoe at a parade”. When one competitor adopts a new technology, others do the same with limited value ultimately accruing to the operators as a whole. Mineral owners, on the other hand, benefit from this dynamic. Unlike operators, mineral interests do not have variable costs tied to production volumes, which means they disproportionately benefit from production growth over commodity pricing. In addition, with the passage of time, an increasing proportion of acreage inevitably becomes economic as technology improves and as operators allocate capital to delineating emerging resource plays.
Active Minerals Management + Low Cost Core Acreage
Black Stone Minerals’ team of landmen, engineers, and geologists actively promote acreage to industry operators and over time have used creative structures to accelerate the development of key assets. In contrast, other mineral owners take a passive approach which reflects a proclivity toward substantially leased and producing acreage. Recall that Black Stone Minerals owns over fourteen million gross mineral acres that are not presently contributing cash flow. This significant unleased position has no associated holding cost and provides an avenue for decades of organic growth. Over the last forty years, numerous oil and gas plays have charted the lifecycle from an emerging to breakout to mature play. The next forty years will be no different. The immense breath of this unleased asset ensures that, where emerging plays do breakout, Black Stone Minerals is likely to have existing exposure. Furthermore, this acreage provides an additional opportunity to enhance shareholder value by selectively accelerating this de-risking process. The most prolific example of this has been Black Stone Minerals’ Shelby Trough position. The Shelby Trough is on the southern end of the Haynesville/Bossier formation in East Texas and encompasses San Augustine, Nacogdoches, and Angelina counties. Five years ago, Encana and XTO were in the early stages of developing a leasehold position in San Augustine County when Encana decided to exit the natural gas business altogether. XTO was unwilling to move forward without a development partner, so Black Stone Minerals joined the lease on a fifty percent non-operating working interest basis. This commitment was unusual for a mineral owner, but allowed Black Stone Minerals to incubate development that could unlock several decades of drilling inventory. The program turned out to be wildly successful and allowed the team to use early insights from operations to nearly double their acreage position in the surrounding counties. Today, the Shelby Trough is one of the lowest cost natural gas plays in the United States and boasts four of the top fifteen wells in the entire Haynesville shale – a particularly impressive feat given the early stage of development. Black Stone Minerals has witnessed a tenfold increase in production volumes from their Shelby Trough assets since partnering with XTO and have more than twenty years of low cost drilling locations remaining across their acreage. In 2017, Black Stone Minerals executed two farmout agreements that released them from their working interest commitments and allowed them to participate going forward as a pure mineral interest owner. A second, smaller, example of active minerals management was the PepperJack Field discovery in the Lower Wilcox trend a few counties south of the Shelby Trough. This was an area that Black Stone Minerals had an existing acreage position dating back to 1992. To the northwest, Unit Petroleum had discovered the Gilly Field which was a 500+ Bcfe stacked pay natural gas resource that boasted 10-20 Bcfe EUR wells with high double digit return profiles. Black Stone Minerals’ goal was to develop a Gilly Field analog by mapping the entire Lower Wilcox trend using 900 square miles of 2-D. There were multiple prospects discovered, including the PepperJack Field in Hardin and Liberty counties. However, it proved difficult to attract an operator to the play on acceptable terms because the Lower Wilcox was a tight sand formation, not shale. As a result, Black Stone Minerals decided to drill a well themselves to help market the acreage with more concrete data. The PepperJack A#1 logged three high quality pay zones that mirrored those of the Gilly Field. In addition, results from a third party evaluation firm estimated the well in the range of 20 Bcfe, a figure that dollar for dollar would rival any natural gas play in the country. The PepperJack Field covered 4,000 acres of high net interest property, more than double the size of the Gilly Field. Within six months, Black Stone Minerals entered into an agreement with an operator that reimbursed them for the program drilling cost and would give the operator an option to further delineate the play after completing the PepperJack A#1. To date, the results from the first completed well are less than had been hoped for. More time and drilling results are needed to evaluate the definitive acreage quality, but nevertheless, this highlights Black Stone Minerals’ ability to incubate development and accelerate operator interest in a play that could result in a highly asymmetric payoff. Fortunately, Black Stone Minerals also has many properties that do not require active management. Their acreage in the Permian, Eagle Ford, Bakken/Three Forks, and Haynesville/Bossier are many of the lowest cost oil and natural gas plays in the country. These positions form the core of Black Stone Minerals’ portfolio and replicating them in scale and quality would be a near impossible task. The Permian and Haynesville/Bossier are less than thirty percent developed, while the Eagle Ford and Bakken/Three Forks acreage is relatively mature. Over time, Black Stone Minerals has been successful in opportunistically bolting-on acreage to these core properties.
Commodity Diversification - Naturally Hedged
There are seven publicly traded oil and natural gas mineral and royalty interest companies in the United States. Some like Falcon Minerals, Viper Energy Partners, and Texas Pacific Land Trust are basin specific players with concentrated acreage positions in the Eagle Ford or Permian. Other competitors - Brigham Minerals, Dorchester Minerals, and Kimbell Royalty Partners - have relatively diversified mineral portfolios covering several liquids focused basins. Black Stone Minerals, however, is the only mineral and royalty interest company that is diversified by basin and commodity. This is important for several reasons. First, the price of oil and natural gas are inversely correlated. More than twenty percent, and growing, of domestic natural gas production is associated gas produced as a byproduct of shale oil drilling. Unconventional oil wells have steep decline curves and in the United States most basins require at least forty dollar oil to incent economic drilling. Therefore, if the price of oil drops to a level that forces production curtailment, then the ensuing shortfall in natural gas supply would swiftly lead to higher natural gas prices and production growth. On the other hand, the headwind to natural gas pricing from associated gas growth is limited by domestic crude consumption which has largely been met over the last decade. Second, the United States is a low cost producer of natural gas but is positioned higher up the global cost curve for oil. This leaves domestic oil production, particularly from high cost basins, vulnerable to geopolitical decision making on the low end of the cost curve. Fortunately, governments around the world rely on income generated from state owned oil and gas entities to balance fiscal budgets. Many countries that can drill profitably below forty dollar oil are incentivized to keep supply in balance in order to achieve adequate pricing. Finally, unlike crude oil, global demand for natural gas is expected to grow for several decades with the United States witnessing the largest call on supply. Steady retirements of coal and nuclear power plants have increased the domestic power generation mix of clean burning natural gas from twelve percent to thirty-eight percent over the last two decades. In addition, planned coal retirements over the next five years are expected to cede an additional six percent of the domestic power grid, or 4.5 Bcf/d of natural gas equivalent. Even still, the largest impact will come from the export of liquefied natural gas. Where pipelines are not feasible, liquefying natural gas provides a cost effective method for transporting natural gas from producing regions, like the United States, to end markets, like East Asia. Unconventional drilling has dramatically increased the amount of gas that can be recovered at a relatively low cost, enabling the United States to transition from a net importer to a net exporter of LNG. At present, the United States has ~9.0 Bcf/d of LNG export capacity, which has grown more than fivefold over the last three years. In addition, a second wave of LNG projects are underway with ~10.5 Bcf/d of capacity under construction, and a further ~20.0 Bcf/d approved by regulators. These are complex long-term projects, but the increased demand for natural gas feedstock will be meaningful compared to the current base production of ~110 Bcf/d.