Stone House Investment Management, LLC

Managing Partner

rstone@stonehousemail.com

570-278-6926

Virtually every fast growing industry has growing pains and the shale gas industry is no different. From political hurdles to ecological concerns to underutilization of natural gas, the shale gas industry has had its fair share of bumps along the road. In this article, we will look primarily at the issue of demand for natural gas and how it will affect the growth of the industry in the short and long term. It has been hard not to notice the precipitous decline of natural gas prices over the past couple of years. The price of natural gas has declined more the 80% from its peak! This price decline occurred while oil prices have climbed to nearly $100/barrel. Why is natural gas falling in price while oil is climbing? Since they are both sources of energy and can replace one another for certain purposes, it would be reasonable to think that they would rise and fall in price together.

The difference in price is largely due to infrastructure, or lack thereof. Oil has been our national addiction of choice for many decades. There are gas stations in every town, home heating oil delivery companies serving every community and plenty of refineries, pipelines and transportation systems to get the oil and oil by-products from the suppliers to the people who want to use them.

This is not true of natural gas. The facilities and distribution systems needed to get all of this new natural gas supply to the places that want to use it are not in place. Consequently, we have more natural gas available than we currently need. When you have more of something than you need, the price falls and in the case of natural gas, prices dropped like a rock. Prices dropped by so much, in fact, that it may no longer be economical to drill for gas in some areas. Some companies are even scaling back development plans for natural gas in our area.

So what is the outlook for natural gas prices and the natural gas industry in our area? The lower prices go, the less incentive to bring new production online. When you think about it, the reason gas prices are going down is because there is too much natural gas on the market. Making more natural gas is just going to make things worse in the short-run. This will likely lead to slower development of leased properties, less natural gas being shipped to market from developed properties and may be bad news for unleased areas like those in NY State.

The ramifications may be seen in local job growth as companies reduce the amount of drilling rigs in the Marcellus and as mid-stream infrastructure projects get put on hold due to the decreased capacity growth expectations. It may be seen in reduced royalties to land owners as fewer wells will be produced and the wells that are produced may not be produced at full capacity. It may cause more wells to be shut-in and more acreage to be held by production as gas companies try to lock in their leaseholds. It may cause much lower lease bonuses and less favorable lease terms for acreage that is not currently leased or that may be up for a new lease. It makes lease extensions of acreage outside of core development areas less attractive and it may lead some companies to not extend some existing leases into a secondary term. It may also cause the value of mineral appraisals to decline as natural gas price is one of the main determinants of value.

That being said, the volume of production in the Marcellus is so significant that it may be enough to offset the fall in gas prices and mitigate some of the these effects. Additionally, each company has its own set of priorities and needs and each will weigh its long-term success with how it handles this short-term utilization issue. Ultimately, the growth rate of our local economy will be much smaller than if gas prices were still in the double digits.

There is a silver lining in the longer term. The cheaper natural gas is compared to oil, the more incentive there is for end users to switch to natural gas. There is also a tremendous potential to sell our natural gas to foreign countries. All we need in place is the infrastructure necessary to utilize the amazing resource right under our feet. Putting it in place, however, will take a degree of political will and for corporations to get behind projects focused on broadening the market for shale gas locally, domestically, and internationally. Over the coming decade, great advancements will be made in natural gas infrastructure with many projects already being planned. As the utilization of natural gas increases, so likely will the price. Until then, though the industry will continue to grow, create good paying jobs and producing significant wealth for leaseholders, it will be at a slower pace than if there were much greater demand for natural gas.

-Raymond “Scott” Stone

]]> http://stonehouseinv.wordpress.com/2012/02/07/growing-pains/feed/ 3 stonehouseinv http://stonehouseinv.wordpress.com/2012/01/20/the-price-is-wrong-unless-its-not/ http://stonehouseinv.wordpress.com/2012/01/20/the-price-is-wrong-unless-its-not/#comments Fri, 20 Jan 2012 17:29:06 +0000 stonehouseinv http://stonehouseinv.wordpress.com/?p=111 ]]> Robert J. Brown

Certified Financial Planner^TM

Stone House

Investment Management, LLC

Managing Partner

rbrown@stonehousemail.com

570-278-6926

This month’s edition was intended to be on tax issues and your chances of being audited, but I’ll table that for a future topic. My reason for changing direction abruptly comes as I am writing this and watching natural gas having its worst trading day in 9 months and at its lowest price in 2 years. At this moment in time, it has dropped about 6% just today but even more eye-opening, it has been literally cut in half over the last 7 months!

Can this continue? The funny thing about trends is that while you’re seeing one, it seems improbable that things could ever tip the other way. As a very pertinent example, I’ll offer up this excerpt which was published in 2006 by the US Government Accountability Office^1:

In early December 2005, wholesale natural gas prices topped $15 per million BTUs, more than double the prices seen last summer and seven times the prices common during the 1990s. For the 2005-2006 heating season, the U.S. Energy Information Administration predicts that residences heating with gas will pay 35 percent more, on average, than they paid last winter.

Wow, how things have changed. I can remember, just a few years ago, back in 2008, when that unit price of gas was up over $11… now it lingers, beaten up under $3. Why is that? What happened? What does that mean for you? That last one may be the most important question for you to ask. Let’s start with the ‘why’.

Supply vs. Demand

It almost always comes down to this model, doesn’t it? That GAO study, done about six years ago, summarizes that during that time our country was seeing an increasing demand for natural gas but a limited supply of it. It goes further to suggest that this can be solved by enhancing our country’s very underdeveloped infrastructure and finding new gas fields, as the current ones (at that time) were old and depleting quickly. Well… mission accomplished… it only took several years to see that happen.

Drilling is all around us now. In 2008, I was driving to various corners of NEPA to see the first drilling rigs (as if spotting a rig was equal to spotting Big Foot) and talk to the crews & foremen. Now, as I drive back and forth to work, I glance at the rigs, casually, like I would a deer standing out in a field. It goes without saying that the gas companies have positioned themselves for the long haul by dropping wells, not only in NEPA, but all across this country. And not just for gas, but for oil and other forms of energy. Technology has changed the game and now this drilling is far more productive than was ever imagined 10 years ago.

Infrastructure has been booming in its development as we see new pipelines in NEPA cropping up each week; linking all of these new wells to their respective distribution hubs. There have been several recent news releases announcing the completion of several major connections which will dramatically increase companies’ abilities to get this gas out to market.

Better or Worse?

In our office, we’ve seen many landowners with a wide variety of experiences. Initial checks are very large and impressive, but the following months drop off in value; sometimes dramatically. Others have had a steady gain in their royalties each month, despite the recent drops in gas prices. Yet still, others have been placed in a production unit but are only seeing a small amount of revenue. Each story is different but the common consensus among them is that once the pipelines are connected, it’s off to the races. Is it? Let’s not count our chickens before they’re hatched.

The missing ingredient to finding price stability and even price appreciation is not in the completion of stronger distribution channels.

Increased Demand is the Key

The much more obvious method of alleviating this inequity is to balance out the scale on the demand side. How do you do that? Can you make the winter colder? That would be a start, but aside from being impossible to do, it would only help the pricing in the very short term. What about the longer term solutions?

Natural Gas is gobbled up in various ways; such as generation of electricity, residential/commercial heating and cooling, and transportation. Each of these has many factors that feed into the ultimate usage of gas but one thing is certain; to date, the increase in demand, although trending toward growth, is just not keeping pace with the massive increases in supply. Simply seeing a drop in temperatures (heating) or a scorcher of a summer (cooling) will not move the dial on pricing too much over time. Long term pricing trends are often more likely affected by changes in the mindset of the consumers, (a willingness to switch fuel sources) in the policies set by our politicians and in the technological advances which provide opportunities to use the gas. (CNG powered vehicles and distribution stations) Until we see such advancements, we may need to get used to the price of natural gas floating near the bottom of its longer term range.

To the Point

It’s important to recognize YOUR role in all of this. You can pick up the flag and push for the causes that you believe in, but you don’t need me to tell you that. I’m talking more along the lines of your relationship with the energy company you have partnered with when you leased your acreage.

It’s important to recognize that each company is different; different how they treat the landowners, different how they deal with their subcontractors, the regulators and the community. As a large company, they are focused not only on 2012, but many years to follow. They have unique financial and economic issues they are facing and thus each landowner will have a unique experience. Their interests may not align with yours. For example, they may prefer to keep the gas contained and very limited in what they bring to the market due to the pricing pressures currently… you may need the cash flow today.

If you take one thing away from this article, please understand that it is virtually impossible for you to predict what your royalties will be in the future. Focus on what IS real… and that’s what is in your check each month. Once it’s in your hand, YOU have full control. Make wise, informed decisions.

Robert J. Brown, CFP®

Direct Link: http://www.gao.gov/new.items/d06420t.pdf

Certified Financial Planner^TM

Stone House

Investment Management, LLC

Managing Partner

rbrown@stonehousemail.com

570-278-6926

As time continues to tick by, I see an interesting trend happening in our area in relation to wealth, or potential wealth, that natural gas landowners are contemplating; people are not sure what kind of help they’re looking for but they know they should be looking for something. I view this whole process of searching for information to be similar to the Internet; you can find a mind-numbing amount of information about so many things on the Internet, but without direction and focus, you will achieve nothing other than killing a bunch of time and maybe a shot at being a viable contestant on Jeopardy!

So, how do you go about organizing your efforts into an efficient approach that will ultimately yield you the results that YOU are looking for so that time can be spent on YOUR situation and lead you toward the best solutions for you and your family? Let me break this into THREE categories and you can determine which best describes you.

Do-It-Yourselfer

• You’re willing to pay for correct information but from that point on, you’ll take it from there.
  
• You have the time to spend on educating yourself and are willing to put a similar amount of time in each year to be sure that you remain abreast of the constantly changing tax and estate laws.
  
• Investment options don’t intimidate you at all. There is a level of comfort you have with navigating through various accounts, allocations, budgeting, cash flows, trading, etc…
  
• The Internet will likely be your largest resource. Take advantage of free consultations and seminars with various professionals to educate you on matters. Ultimately you will rely heavily on tax software and updates to the tax codes and estate laws.
  

Delegator

• You want to be educated but not overwhelmed.
  
• While meeting with professionals in their respective fields of expertise, you are also vetting each of them as you search for one, or several, that you would prefer to work with going forward.
  
• Once you have found the right ‘team’ of people, you excel at coordinating each of them in an organized effort to get the job(s) done.
  
• As long as there is a value for the service, you are comfortable paying an amount in exchange for expertise, knowledge and the ability to free up your time to be spent in other areas of life that are also important to you.
  
• In addition to your initial selection process, it will be equally important for you to have a method of measuring the value you realize from each source and understand the ramifications, if any, of choosing to go elsewhere with your business should things not work out.
  

One-Stop-Shopper

• This entire process is daunting to you.
  
• You would prefer to seek out one person or one firm that can handle all of these decisions for you.
  
• As the years go by, your perceived benefit would be only having occasional conversations with that same person/firm about any changes in your life and evaluating where all things stand.
  
• Finding that ideal person/firm will likely take longer as there are fewer options to choose from. However, should you find one that you’re comfortable with, the match could be a long term winning solution.
  
• The cost for this service may seem pricey, but they should be doing quite a bit more for you than most places. In fact, using one location may actually result in an overall lower cost to you versus going to multiple providers.
  

Solutions

To the point, determine what type you are first, before you run in every direction. Depending on your selection, your criteria will change as to how you should proceed. For example:

Do-It-Yourselfers will need to fire up their computers and free up their time to find appropriate accounting software and bookmark popular and trusted websites. I suggest starting with www.irs.gov.

Delegators will seek out professional expertise; such as accounting, investing, legal, etc… After first making a list of the services they want, they should then take a two-pronged approach to this:

First, use the Internet, newspapers and other media to find a valid list of professionals that may fit what you’re looking for.

Second, talk to others in your situation, which you trust, and listen closely to their experiences with various advisors/attorneys/accountants. Put the usual filter on as you listen to them talk about their experience. Listen for how those professionals communicate with them. Is it often, open communication without an adversarial feeling? It should be. This should be a partnership, going forward. You’re not seeking a dictator here; rather a partner to place on your team.

One-Stop-Shoppers need to dig deep into all various sources to find the few firms that can provide the robust services they need. Firms like that are not high volume shops, so be prepared to have substantial in-depth conversations at these locations as you BOTH get a feel for each other and a strong understanding of how the relationship will work through the years.

Last Thought

I’ll mention one additional benefit that ‘one-stop’ firms can provide. Regardless of which type of person you are, what happens when you’re gone? Eventually, the bell tolls for each of us. If you’re a Do-It-Yourselfer, is your spouse the same type? What about your children? One of the hardest things for us to realize about transferring our estate to our family is that we’re not going to be there to make sure it gets done. Choose wisely!

Raymond “Scott” Stone

Stone House

Investment Management, LLC

Managing Partner

rstone@stonehousemail.com

570-278-6926

One of our primary functions is to try to protect and grow our clients’ money. You’ll notice that I said “protect and grow” in the same sentence. What a challenging thing to try to both protect and grow our clients’ money in this environment. It seems the world is on the edge of collapse on Tuesday, then everything is fine on Wednesday, then we are back to Armageddon on Thursday. It is virtually impossible to know what will happen tomorrow due to all of the conflicting information, continuously changing global politics and unprecedented financial circumstances across most countries in the developed world. As soon as one zigs, the stock market zags almost as if it is laughing at those of us doing our best to figure it out. It is frustrating, but this too shall pass. In this article, I will try to explain what is going on in the world and why these are the best of times, these are the worst of times.

Volatility… Just the word makes me cringe… After four and a half years of unrelenting volatility, some investors are fed up. They are cashing in their chips and leaving the casino. I can’t say I blame them, but is that wise? Could they be leaving just before the party gets good? Let’s take a look at what’s happening in the world and why this may be the greatest opportunity in a generation to invest if you can stomach the ups and downs.

The world….. It’s big, but sometimes it seems small. Take now, for example; our wealth as a nation and a globe is changing dramatically based on news reports from small European countries to which most of us have never been. Your retirement account may have dropped 4% in a single day simply based on a statement made by the leader of a relatively tiny country thousands of miles away. We are all connected by what has evolved into the global financial system. Each country is a domino leaning on each other country and they are all praying none of them topple. When one does, it is a race to put support in place to prevent the rest from getting knocked down. This is why the small country of Greece matters. It is the canary in the coal mine. If the domino of Greece falls, what domino is next and will we be able to prevent the entire system from crashing? Through the past year and a half, Greece has been wobbling. Not quite falling, but wobbling. They have too much debt and no chance of ever paying it off. They are teetering on bankruptcy. With each wobble the market moved in tremendous amounts down, then up again… down then up again; most of these movements based on statements made by government officials, or reports by analysts estimating the damage that has been and could be caused by the collapse of Greece. Now the fear has spread to Italy and has made the situation even more perilous. Though Europe is working toward a solution, they are slow and indecisive. The clock is ticking, and though I ultimately feel they will find a solution, it will be a roller coaster ride until we get there.

Enough about Europe, what about us? What is happening in our country? The interesting thing is that this past summer, it was much of thesame. We found ourselves at a point where we had more debt than was comfortable. Without getting too lengthy with the discussion, we were afraid of fear; afraid that people would become fearful to loan us money. That would put us in a very, very bad position. Fortunately, those fears never came to fruition and we found that due to the instability in other countries, investors are tripping over themselves to loan us money. So where does that leave us? We are in a modest, but steady recovery from the worst financial crisis since the great depression. Regardless of what was thrown at us, we clawed our way up to our feet and went back to rebuilding our country. Stocks are selling at huge discounts to the prices they normally garner based on the strength of the companies they represent and with historically rock bottom interest rates, their dividends look like attractive alternatives to bonds. So though there is a lot to fret about with Europe, the US seems to be doing just fine, leading to even more confusion among investment managers as we try to determine what is more important: The US improving, Europe crumbling, or the Emerging Markets holding steady.

This brings me to the point of this article. With investments, it is always darkest before the dawn. Just when you feel like you can’t take it anymore, the clouds part and the sun comes out and life returns to normal. It is times like these that can present the greatest long-term investment opportunities. The opportunity to buy at sharp discounts and watch your investments grow at above average rates for years, sometimes decades. Could we be living in that moment right now? Could this be one of those magical times? There are certainly many reasons to think that it could be but no one ever really knows for sure until you are looking back at it ten years from now wondering why you didn’t act. The threat that Europe poses to the world is real and should not be ignored, however, collapse of the European Union is far from a certainty and outside of Europe there are some great things going on. At some point, we reach a conclusion to the European financial soap opera. If Europe finds its way to stability, the stock market will present a tremendous opportunity for years to come as we move from contraction to growth and more participants enter the market allowing multiples to rise. Until then, we will sleep with one eye open watching Europe and hoping for a brighter day.

]]> http://stonehouseinv.wordpress.com/2011/11/10/the-world-and-your-investments-turbulent-bed-fellows/feed/ 0 stonehouseinv http://stonehouseinv.wordpress.com/2011/10/10/planning-is-not-a-race/ http://stonehouseinv.wordpress.com/2011/10/10/planning-is-not-a-race/#comments Mon, 10 Oct 2011 15:14:35 +0000 stonehouseinv http://stonehouseinv.wordpress.com/?p=89 ]]> Robert J. Brown

Certified Financial Planner^TM

Stone House

Investment Management, LLC

Managing Partner

rbrown@stonehousemail.com

570-278-6926

As local landowners continue to gain experience with drilling and royalties, we continue to hear occasional sad stories of errant moves, family turmoil and loss of control. Just a few of the following examples might help to give you perspective into the world of financial planning and how it relates to natural gas planning. It will be comforting to many of you to see that you’re not alone in what seemingly can be a confusing subject as so many families in our area are attempting to map out their futures.

“I just got one of those LLC’s” – People have come up to me after a seminar or in other public forums to tell me about all of the estate work they already completed and how they can sit back and relax. As an example, I’ll hear “getting that entity thing set up cost a few grand but that’s what my neighbor suggested so I set one up.” The warm fuzzy feeling that you had when your entity was set up sometimes fades away when we dig a little deeper and talk about things that should happen this year and the following years to make all of that upfront cost worthwhile. Things like:

• Transferring assets into the entity and paying any taxes due.
  
• Gifting a portion of the entity (and your future royalties) away to your heirs starting now.
  
• Setting up a schedule of future gifting to assist you with your long-term goal of shrinking your estate before you die in order to maximize what goes to your heirs. Nothing needs to be written in stone, but you should at least have an idea of how much you plan to gift and how often you’ll make these gifts.
  
• Performing the necessary procedures within your Limited Partnership and/or LLC to help ensure its validity as a legitimate business.
  
• Communicating this family structure to the rest of the family. If they’re involved in it, whether they own a portion immediately or not, knowing the details would dramatically increase your chances on long-term success. Being kept in the dark leads family members to draw conclusions and make assumptions… which never make for a healthy environment in any family.
  

“It was going to be a lot of money for all that estate planning so we’re just going to settle for whatever happens to come our way.” – OK, but it doesn’t have to be that way. There is a tremendous amount that you can do to begin transitioning your estate to your children without using a fancy entity or trust. Those types of things may prove ultimately to be the better choices but if you don’t have the money to set them up today, then what good are they to you? Estate planning is seldom black and white. What works today may not be a good solution in three years, which is why flexibility should be built into everyone’s plans. Estate and tax laws change frequently so finding alternate ways to get things started may be challenging in itself but well worth the time you spend on it.

“My situation is too complex. I can’t even begin to imagine how we could get everyone to agree on everything.” – There is no magic pill for scenarios like that, however, the default is usually that NO planning happens and this all gets sorted out after you die anyway. And, yes, it will typically be settled by the same group of people who you swore would never be able to agree upon anything. Unfortunately, the only one missing from this group… is YOU!

If you feel passionate and determined about where your hard-earned assets should go upon your death, then you need to take the steps necessary to ensure that happens. Just letting the chips fall where they may, could lead to a larger portion of your estate ending up in the hands of the government, or to an heir with the strongest attorney.

Either way, there will eventually be a tremendous amount of discussion centered on your estate. Don’t assume that things will just sort themselves out. For years, siblings have fought over Mom’s jewelry (worth $4,500?) or Dad’s guns (worth $7,200?). Don’t think for even a second that there won’t be disagreements over Mom & Dad’s $2 million dollar royalty producing property. The best time to exercise your control over the situation is while you’re able to put it in writing via a will and other estate planning tactics.

“I have a simple goal: to split my estate between each of my children, but it seems unfair since my son lives on the property and my daughter lives on the other side of the country.” – This one is pretty common (in our office) and may be fairly simple to formulate a plan. Most of us in Pennsylvania have been so used to dealing with the surface of our properties that we have never expanded our thought process to consider the sub-surface as a completely separate part of our estate. Well, it’s time we start thinking differently and this is a perfect example where it would apply.

Some of us have already devised a plan for our surface property. In the above scenario, Mom and Dad may leave their land to their son and perhaps more liquid assets (ie: cash, retirement account, CDs) to their daughter; to make up the difference in what the land was worth.

The same common sense can still apply, but they now have an additional asset to consider. Mom and Dad can now sever the sub-surface rights from the surface and treat them differently when it comes time to divide up their estate. Therefore, their son can have all of the surface land (if that is what they intended) and their daughter may receive more of the natural gas interests to try to equalize the value that they each receive from the estate. Another benefit is that the daughter can own natural gas interests from thousands of miles away without having to be there on hand to make daily decisions or walk on the property like a surface owner sometimes needs to do.

For those working with the scenarios of second marriages, extended families, grandchildren, stepchildren, etc… this can be a very valuable technique which enables you to divide the sub-surface rights by percentages rather than outright ownership by one person or several equal owners. The ownership can be unequal and does not have to be in the same percentage as the surface.

“What should I do first?” - Do yourself, and your family, a favor and talk to financial planning firms, attorneys, CPA’s, etc… to get educated about your situation before you do things that are irreversible, costly or not in your best interest. We preach flexibility when it comes to planning and I think the natural gas industry combined with ever-changing estate tax laws makes a strong case that you’ll need to make adjustments down the road. If you are learning how to manage your wealth, talking with professionals who have experience in doing just that makes sense. Regardless of whether you use their services going forward, you will gain perspective and education.

Robert J. Brown, CFP

Raymond “Scott” Stone
Stone House Investment Management, LLC
 Managing Partner
rstone@stonehousemail.com
570-278-6926

This month, let us take a look at a common and costly issue in natural gas planning – mineral right appraisal, transfer, and taxation. First, a disclosure; we are not attorneys and none of the following should be considered legal advice. See your own attorney regarding these topics before taking any action. Also, as most of the natural gas planning we deal with is regarding properties in Pennsylvania, we will focus on this state but these issues will vary from state to state.

“Why should I do estate planning?” Let’s start by framing the issue so we have some general knowledge about why there are discrepancies in opinions on this topic. Estate planning is primarily used for two reasons. First is to ensure that your wealth goes where you want it to in your life and death. With proper planning, you can direct money to specific people and for specific purposes in life AND after you pass away. Without planning, some may find themselves in a position where all of their wealth goes to a person they never intended to receive it. The second reason is to minimize taxation. The six main taxes that people try to minimize with estate planning techniques are: Federal Estate, Federal Gift, PA State Inheritance, PA State Realty
Transfer, Federal/State Income and Capital
Gains.

Each of these taxes has its own rate and calculation methodology and its own set of loop holes. Estate Planning is usually done in a way to minimize overall taxation while still ensuring that the money ends up in the hands of the right people and/or institutions after you’re gone.

With this in mind, the steps to estate planning should be to first determine who should be receiving your wealth, how much they should receive, when they should receive it, and what restrictions should be placed on their use of your wealth. Once this is known, then a plan is devised to do this while minimizing taxes. Sometimes the timing, size, or form of gifting is altered to maximize tax benefit.

Many attorneys believe that minerals are subject to PA Realty Transfer Tax. This is a 2% tax split between the state and local governments that is charged against the value of a piece of realty being transferred from one owner to the next. There are some exemptions for transfers between family members, but many attorneys don’t believe these exemptions apply if you are incorporating a family entity. Some attorneys are recommending not transferring the assets themselves, but instead creating contractual obligations requiring the parents to route royalties to the entity, thereby circumventing Realty Transfer Tax.

“What is an appraisal and why do I need it?” Once you get through this quandary of whether your transfer of mineral interests or royalties is subject to realty transfer tax, you have to then determine how much realty transfer tax you owe and what your estate may owe to the IRS for any maneuvers of minerals or royalty interests into or out of your estate. To do this, you are required to determine the “Fair Market Value” of the property. This is defined by the IRS as “the price that would be

agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts. If you put a restriction on the use of property you donate, the FMV must reflect that restriction.”

Who is qualified to make such a determination? No one really knows how much gas is under there; how much of it will be recovered; how quickly it will be sent to market; what natural gas prices will be a decade from now; or what taxes may be imposed on natural gas production in the future. If you don’t have production on your property currently, there is no guarantee you will ever have production or what that production will be. How do you put a number on that? Many attorneys recommend that you use a Certified Mineral Appraiser as they are theoretically most qualified to determine what the gas under your property is worth based on some broad assumptions about many factors. Need another example? Rumors of other shale layers and the holy water of energy, oil, typically aren’t factored into appraisals. Why? There is no way of knowing how to value these potentially world- changing resources that may reside under our feet.

Some believe that the truest determination, the only real determination, of fair market value for this real estate, particularly regarding the properties that do not currently have production on them, are the prices of comparable interests sold. Referring back to the definition of “Fair Market Value” doesn’t that sound right to you? The best person to determine what someone is willing to pay for your property is likely the person who is actually licensed in Pennsylvania to tell you what someone is willing to pay for the property: A Certified Real Estate Appraiser. Yes, like the one that told you how much your house is worth. Here is a secret, real estate appraisals can be about 1/10th as expensive as mineral appraisals. Obviously, it would have to be done by an appraiser that is familiar enough with the prices being paid for the exchange of mineral rights and the adjustments needed from property to property to make a sound judgment. They would also have to be willing to defend their appraisal if you are audited by a taxing authority. Unfortunately, these

transactions where mineral extraction is the highest and best use of the property are not as common as home sales, so finding a comparable can be difficult. Without a sufficient number of comparable properties, the Real Estate Appraisal breaks down.

This creates a stronger argument for a mineral appraisal, especially if there is already production on the property as it then becomes more similar to a functioning business than passive real estate ownership. This however raises the question as to a whether a certified business appraisal is also needed especially if the rights are held within an entity like an LLC or LP. This would be yet one more added cost. Additionally, the surface of the property is still worth something and depending on what type of planning you are doing, you may have to get the surface appraised by a real estate appraiser in addition to the mineral appraisal and the business appraisal. As if that wasn’t enough, you’re responsible for determining the fair market value at the time of each transaction, so if you are trying to execute an annual gifting plan, you may have to get new appraisals each year. Make sure you consult your attorney before making any judgment on this topic.

“Do I have to pay Realty Transfer Tax?” You have gotten your mineral rights appraised and now you are ready to transfer them. Even if your attorney determines that your mineral transfer is subject to PA Transfer Tax, certain transfers are exempt from the tax, like the transfer of property between immediate family members. Hmmm… isn’t that what you’re doing; transferring mineral rights to your kids? Why would you have to pay realty transfer tax? If you utilize a family entity as part of the process, like an FLP, many professionals don’t believe the exemption still applies. Consequently, you end up paying the tax regardless of the fact that you are ultimately transferring the value created by the minerals to your kids, which would normally be exempt from realty transfer tax if not for the fact that you are using a family entity. If your appraisal of the property being transferred comes in at $10,000/acre and you have substantial land holdings, then the realty transfer tax could be tens of thousands of dollars.

“So why would I set up a family entity if it is so expensive and tedious?” The concept of the family entity is to primarily allow for gifting of mineral rights to the kids at discounted rates based on things like lack of control and marketability while the parents retain full, consolidated control of the mineral rights which protects and streamlines the decision making process. It also serves to structure gifting in tax efficient ways and allows parents to involve their kids more fully in the wealth management process. Hopefully, the education will help prevent them from making bad decisions with their wealth later in life. To some degree, family entities also allow parents to restrict or redirect the flow of money to the kids, and can be used to prevent mineral interests from being sold to non-family members, but you have to be very careful not to violate any fiduciary responsibility you may have to the kids within the entity and also retain the entities legitimate business purpose so as not to have the IRS “bust” your family entity. There are many other issues including “gift of current economic interest”, codification of the “economic substance doctrine”, income, estate, gift, inheritance and capital stock tax efficiency, gifting through trusts, life insurance, entity structure, as well as liability, creditor, lawsuit, and divorce protection, etc.., that are all very important in the planning process. Just “having an FLP” is not enough. Family entities are far from a one-size-fits-all approach and there is continuous monitoring and maintenance that need to be done to reflect family dynamics and changing tax rules. Unfortunately, much of this planning is done based on assumptions of tax law and tax rates years, even decades, into the future. We don’t even know what taxes will look like in 2013, much less 2035. Over the course of the next 20 years, congress may completely do away with Estate Tax making much of this planning (and the money and time you spent on it) futile. On the other hand, tax rates may be increased substantially and if you don’t do the necessary planning now, it could cost you 70% (or more) of your wealth in taxes upon your death. Much of it comes down to the years in which the parents die. If “death tax” rates are high that year, you will wish you did the planning. If they are low or non-existent, you may wish you saved your time, money, and flexibility.

Bottom line, there are relatively simple, flexible, and cost effective ways to gift and reduce your potential death taxes, but they don’t have some of the benefits of FLP’s/LLC’s. In many cases, the benefits of a family entity will go unutilized or underutilized due to a variety of factors; the largest of which is lack of landowner education and poor coordination between the professionals that they work with. In these cases the “Keep It Simple” approach may ultimately be the best option. Tools including wills, trusts, direct gifts of fractional mineral interests, life insurance, etc. can be used to provide a practical alternative to family entity planning. Discuss these issues with your accountants, attorneys, financial planners, insurance agents, and appraisers to determine the best strategy for your family.

Raymond “Scott” Stone

Robert J. Brown
Certified Financial Planner^TM

Stone House Investment Management, LLC

.

Last month I wrote about the “good” problems that royalty owners are facing in Northeastern PA these days. Given the response I’ve had, it only seems to make sense to dig into a few of these a little deeper to help those landowners find solutions.

Many of us have had lump sums added back into our cash flows over the years; maybe a fairly sizable amount from an inheritance or much more commonly, a tax refund in the springtime. Remember how excited you were to find out this money would be handed to you and how it would change things for you as it allowed you to take a deep breath and pay down a debt or buy something you’ve always wanted? Fast forward one year later… you’ve already added more debt back to your balance sheet… or that thing you bought is nice, but there is something new out there now that’s catching your eye again. It’s at that point that we ask ourselves, “Where did that money go?”

Royalties put a nice new spin on this scenario because they are recurring lump sums. However, as I mentioned last month, they often fluctuate by large amounts and they are not guaranteed to last forever.

Here are some of the main issues we address with our natural gas clients:

• Prioritize – Pay down debts, refinance debts, taxes, special uses or projects, retirement, reserves, gifting… What makes the most sense on paper may not be the way you prefer to do it. Do it your way, but understand why you’re choosing to go that route and how you’re going to make it work.
  
• Break Your Checks Up – Consider setting up multiple accounts for different purposes like the ones mentioned above. Each month, when your check is deposited, transfer a specific percentage to each of your other accounts every month. For example, 35% for taxes, 25% for debt, 10% reserves, 10% retirement, 15% home improvements and 5% gifting. This is a generalization but you get the idea. This compartmentalizes money into categories which helps most of us better visualize how to manage it.
  
• Taxes – Work closely with your accountant on this but he/she should be able to provide you with an estimated percentage to sweep into this account. Please remember that you will very likely need to pay Quarterly Estimated Taxes as this money comes in so this account will likely be filled up and depleted each quarter but separating it from your other money from the beginning will help to prevent accidental overspending or falling short when it comes time to pay Uncle Sam.
  
• Pay Off BAD Debt – In general, credit cards and any high interest loans are the primary target here. With today’s current interest rates at or near historic lows, paying double-digit or even
  

  high single-digit interest to lenders is not something that one should be in the habit of doing. Paying off this type of ‘bad’ debt is typically high on the priority list.
  

• Evaluate GOOD Debt – It’s hard to believe there is such a thing as ‘good’ debt, but most accountants and financial planners would agree that sometimes it makes sense to carry some debt if it is a cheap cost to borrow and/or it is considered tax-deductible interest. With all of the changes to the tax codes, it pays to have a professional who can stay on top of things and determine which, if any, of these debts you may wish to keep and which you should pay off.
  
• Emergency Reserves – Something will come up that you never expected. It always does. Let me say that again… it ALWAYS does. Sweep a little off of each check into a reserve account that is very liquid and very stable. At least when you tap into it, although you will be reluctant to have done so, you will be happy that it’s all there.
  
• Specific Uses – Maybe a better term for this account would be the “fun stuff”. Whether it’s a new truck, equipment, an addition to your home, remodeling, a pool, travel, etc… all of these come with a price tag. Working it into your budget will help to keep it in perspective and hopefully reduce buyer’s regret should future checks shrink substantially.
  
• Retirement – Most of the world has to build their long term savings plans by tens or hundreds of dollars at a time, but royalty owners often have the luxury of doing it by the thousands. That’s an enormous advantage; one that should not be overlooked or taken lightly. By using basic, conservative estimates, you can determine an amount or a range that should be targeted and work month by month to fund that goal. With Social Security under tremendous pressure in the long run, this should be a priority for most people.
  
• Gifting – Often, the best way to gift to your children, grandchildren and even to charities is over the course of time and within your means. In the back of your mind is always the concern that you might be giving away too much and hurting yourself in the long term. In some cases, this causes people to not gift at all. By itemizing things as listed previously, you will have a much better understanding of what you can afford to pass to others and when you can afford to do this.
  
• Retire Early – When that first check or two arrives, you may give serious consideration to an early retirement from your job. Take great caution in this, as many landowners who have been through it are glad they stayed employed as their checks have varied in amounts and not provided quite the cushion they expected. It can work the other way too so be sure your financial house is in order before you separate from that steady income stream provided through your employer.
  
• Fear Of The Unknown – As you build out your wealth by using these various accounts, you will inevitably look to expand your investments into areas that you are not familiar with or have no experience with; such as stocks, bonds, CDs, real estate, annuities, etc… All investments have risk; even cash is susceptible to inflation risk. Rather than fearing any of these and eliminating them from your list of options, it is better to understand them. Research all that is available, how you would invest in these and the pros and cons that exist. At that point, you can best determine which of them would be a good fit for you and which would not.
  

All of the items mentioned here are meant to provide insight as to how professionals are helping their clients make decisions. If you are learning how to manage your wealth, talking with professionals who have experience in doing just that makes sense. Regardless of whether you use their services going forward, you will gain perspective and education.

Robert J. Brown, CFP®
 

www.StoneHouseInvestmentManagement.com
(570)278-6926

(570)836-7020

A statement like that might make most people raise an eyebrow and scoff at the idea that money wouldn’t be able to solve all of their stress-inducing problems. But for those select few in NEPA who have already been receiving royalties, you may have a different vantage point now than maybe say… two years ago. There are others out there who expect to be on that list of royalty owners sometime in the near future too. Either way, you may find it an eye-opening experience to catch a glimpse into your future and see some of the issues that families in our area are learning to manage.

Let me start with the same statement that I often tell wealthy clients; these types of problems are typically good problems to have. With that said, if not handled correctly and with care, it would not be the first or the last time that a financially positive event suddenly took a bad turn and spun into something ugly. Some families have been brought closer together as they’ve gone through the planning process and now have a much better understanding of where they stand and their expectations can be managed. Other families have gone through a more difficult path; one that
consists of family rifts, inaccurate assumptions, a struggle for authority and control, etc…

How can you avoid the unpleasantness and only have the upside? Some things cannot be avoided, but the best way to arm yourself and your family is to continue your education. I’ve hosted many seminars on natural gas topics and also have been in the audience in an equal amount of them. People would attend in droves to find information about leasing and some have continued further to learn more about pipelines and right-of-ways. All of which are vitally important to your future. Yet, so many landowners have gotten to that point, only to stop and kick their feet up as if the hard work was over. Really? Is that what you think?

I could understand this way of thinking if you spent all day at your job and just don’t feel like looking at financial matters because you need some down time. But this is much, much bigger for many landowners. For some, this is doubling or tripling their normal yearly income. Other will see even more. Many have committed to retiring or quitting their normal jobs/careers once royalties begin. That’s what you call life-changing money!

So, if you won the lottery for $5,000,000… would you squirrel it all away in a Mason jar in the backyard? Probably not; I don’t think they make jars that big. Would you go out and buy a bunch of toys and various unnecessary items just because you finally could? Maybe? Perhaps that’s why so many lottery winners find themselves poorer now than before they found that winning ticket.

With so much at stake, this is not the time to be complacent. After the leasing and pipeline negotiations, much of what happens is likely now

out of your control. But with your royalty checks… that is totally in your hands now. What you do with it from there is your gain or your loss. Even when you make mistakes (and you will, we all do) you can adapt and make better choices. The only thing that would prevent you from correcting a mistake is to not even know that you’re making one! Education!!!

To list all that I’ve seen would take a book. Perhaps if there is interest, I could provide more details to some of these, but for now, some common issues that royalties are creating:

• Fluctuating Amounts- These checks can go way up and way down. There are many reasons for this, learn what those factors are and understand that this volatility is almost a given.
  
• Suddenly Stop – Not as common, but certainly a possibility. Did you increase your monthly expenditures based on the first few months of checks? (new home, new car, bought more land, etc…) If you didn’t pay cash, will you have enough if your check is no longer in your mailbox? Please be careful!
  
• Giving It Away – When something good happens to us, we sometimes instinctively want to share it with others. This philanthropic feeling is virtuous, but please remember to take care of yourself too. People and organizations tend to manage small, recurring gifts better than one large lump sum gift. Consider dividing your gift into smaller portions, or using a foundation to create a stream of income to your favorite charity.
  
• Communication – Estimating what a land owner may get in royalties is fairly straight forward math once you know what wells in the area are producing. Certainly your other family members will attempt these calculations. Unfortunately, landowners rarely receive these maximum numbers due to unitization, capacity restraints, production plans, well maintenance, and a host of other potential reasons. Many families have misconceptions about what “Mom
  and Dad are getting”. Try to avoid family members making false assumptions by pointing out that royalties almost never flow according to best case scenarios.
  
• Protect Your Finances – When many land owners receive their bonuses and royalties, they “put it in the bank”. With interest rates so low, why would they do that? It is because they feel that this is the safest thing to do. In many cases, it is, but did you know that FDIC insurance only protects you up to $250,000 per registration per bank (some exceptions)? That means if you have put $500,000 in your checking account, it is very possible that $250,000 of that is not guaranteed and could completely disappear in a worst case scenario! Simply by changing the registration on your accounts or using multiple banks, you can better protect your “safe money”.
  
• Take Taxes Out As You Go – Most people understand this concept but some fail to do it. The last thing you want to be doing at tax time is scrambling for the money that you should have set aside, or paid in as quarterly estimated taxes during the year. What If those monthly royalties have dropped substantially or even stopped? You may have difficulty finding the money to your taxes.
  
• Ask For Help – There are many good professionals who will host an initial free pay consultation. Take advantage of this face-time and listen closely to them. Meet with several and get some general thoughts on where you stand. You’ll feel more empowered with what you’ve learned.
  

At the end of the day, the reality here for many of you is that the dollar amounts you are dealing with are substantial. The same mistakes you’ve made in the past that may have lost you $100 here or there could now cost you $10,000 or more simply due to the increase in income. Where I come from, that’s still a lot of money; and worth my time to pay attention to it.

– Robert J. Brown, CFP®