Monday, February 28, 2022

Is Dorchester Minerals LP Just a Depleting Asset?

The average price per barrel of oil sold by Dorchester Minerals was $59 last year. Crude oil spent almost all of 2006 above $60. At year-end 2006, Dorchester's proved reserves were 3.8 million barrels of oil and 66 million mcf of natural gas, with 28 million units of the partnership outstanding. At the end of 2021, reserves were 9.2 million barrels of oil and 38 million mcf of natural gas, with 37 million units outstanding.

So the oil reserve per unit has grown but the natural gas reserve per unit has shrunk. But keep in mind that the price of natural gas was over $6 per mcf in 2006 and was under $3 last year, and that would decrease the reported natural gas reserves for 2021, other things being equal. (Normalizing for this is why we pick a date when the oil price was roughly the same, because reserve engineers give a higher estimate of recoverable hydrocarbon quantities when commodity prices are higher.)

Also, if you use a 20:1 ratio for the relative economic value of oil and natural gas (instead of the 6:1 energetic equivalence), then you have 7.1 million barrels of oil equivalent (boe) in 2006 and 11.1 million boe now. That is 0.25 boe/unit in 2006 and 0.3 boe/unit now. From 2007-2021, Dorchester paid $26.12 per unit in distributions, greater than today's price per unit, and managed to slightly grow the proved reserves of oil (equivalent) per unit.

If Dorchester were just a depleting asset, their sales of oil would result in a finite pool of oil shrinking over time. Since the reserves are growing, it means one or both of two things: the proved reserve metric understates the total amount of ultimately recoverable oil in their land, and/or the acquisition of new land using partnership units is having an accretive effect. But either way, the partnership was not just a "depleting asset" over the past 15 years.

So how would an investor have done owning Dorchester units over the past fifteen years, starting at the beginning of 2007? One interesting calculation to make is to look at the outcome if an investor had reinvested the quarterly distributions in more units of the partnership.

It turns out that the points in time where the dividend yield is high (when the prices of DMLP and/or oil are distressed) are very powerful in the compounding effect of distribution reinvestment. The reinvestment of the November 3, 2008 quarterly distribution grows your stake by 4.3%. The reinvestment on May 14, 2020 grows your stake by 4.7%.

The result of the compounding is that one partnership unit purchased in January 2007 grows to 3.5 units with dividend reinvestment over the 15 year period. Those 3.5 shares are worth $83.34 now on a starting investment of $21.50. That is an IRR of 9.35%.

This is particularly impressive since the valuation has fallen (the Dorchester distribution yield has increased) from 8.55% (annualized) at the start in 2007 to 10.8% (annualized) today. If the yield today matched what it was at the beginning of 2007, the price of a Dorchester unit would be $29.90 and the IRR would have been 11%.

Note that the time periods when Dorchester is richly valued actually lower the IRR that an investor following the long-term distribution reinvestment strategy earns. As an example, the highest price that an investor would have paid during the fifteen year period for units was $34.16 in July 2014, which was only a 5.6% yield on that quarterly distribution (annualized). If the units had instead been trading at the same yield as today, the unit price would have been $18.15, and an investor would have been able to buy more units, and so the IRR would have increased slightly to 9.4%.

These calculations seems like a good reality check of Dorchester's model of accretive land acquisitions using partnership units. They would also tend to show how the market does not ascribe enough value to the non-producing reserves of non-operating mineral owners.

Non-operating mineral investments (e.g. royalties) seem to trounce operating (exploration and production) investments. (The S&P Oil E&P ETF is down about 30% since 2006, not counting dividends.) This seems to come from poor capital allocation as a result of principal-agent conflict in the oil and gas business.

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