COMMODITY PRICE VOLATILITY AND THE IMPACT TO 1031 EXCHANGE INVESTORS’ CASH FLOW
RISK #1
The most obvious risk is the direct exposure to oil and gas prices, which are notoriously volatile. Investing in a mineral rights offering that is trading at $100 a barrel looks like a good investment. However, the same offering can quickly become economically unfeasible when prices fall to $50. Unlike properties with long-term leases to credit tenants, mineral rights do not offer predictable cash flow. Instead, revenue is entirely dependent on commodity prices set by global markets beyond an investor’s control.
UNLIKE PROPERTIES WITH LONG-TERM LEASES TO CREDIT TENANTS, MINERAL RIGHTS DO NOT OFFER PREDICTABLE CASH FLOW.
PRODUCTION DECLINE AND RESERVE UNCERTAINTY AND HOW THIS CAN DECREASE CASH FLOW TO 1031 EXCHANGE INVESTORS
RISK #2
Even when drilling is successful, oil and gas wells follow a steep decline curve: production is strongest in the first few months or years and then falls off sharply. Forecasting long-term returns requires accurate reserve estimates, which are inherently uncertain. Overstated reserves or disappointing well performance can leave investors with dramatically lower distributions than expected. The main reason why an investor in a 1031 exchange would even consider investing in mineral royalties is because of the high cash flow stated. However, the reality often is much worse than expected.
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