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Today we’re bringing you an insightful conversation with 
Tim Pawul, one of the clearest voices in energy alternative investments. Tim is the founder of a merchant bank specializing in oil and gas mineral rights, royalty interests, and non-operated working interests—a sector most investors have heard of but few truly understand. Based in Houston, Texas, Tim has spent over a decade at the forefront of oil and gas investing, earning a reputation as an expert and thought leader in this space.
In this episode, Tim joins Dave Wolcott to demystify how sophisticated investors can harness the powerful returns and tax advantages of mineral and royalty investments, even without direct experience in the energy sector. Tim shares his journey from Rice University graduate to becoming a central connector of institutional players, managers, and investors in oil and gas. You’ll gain an exclusive look into the recent institutionalization of these asset classes, why technology has transformed the sector, and what sets it apart from conventional public energy stocks.
Whether you’re looking to diversify your portfolio, minimize risk, or learn about 1031 exchanges and energy-backed passive income, this episode offers a masterclass in understanding both the macro trends and the nuts-and-bolts of investing in the booming minerals and royalties market.
In This Episode
- Tim’s path to becoming a leading expert in oil and gas minerals, royalties, and non-operated interests
- Macro trends and institutional evolution shaping energy investments
- How minerals, royalties, and non-op interests work—and their unique risk-return profiles
- Strategies for tax efficiency, portfolio fit, and leveraging 1031 exchanges in energy investing
For all intents and purposes, you really want to be going direct on 1031s in order to, you know, get your real estate proceeds into mineral assets and vice versa. But just holistically knowing that they’re 1031-eligible is something people don’t really know, right?
Welcome to the Wealth Strategy Secrets of the Ultra Wealthy podcast, where we help entrepreneurs like you exponentially build wealth through passive income to live a life of freedom and prosperity. Are you tired of paying too much in taxes, gambling your future on the stock market, and want to learn about hidden strategies for making your money work for you? And now your host, Dave Wolcott, serial entrepreneur and author of the bestselling book The Holistic Wealth Strategy.
How’s it going, everyone? And welcome back to another episode of Wealth Strategy Secrets of the Ultra Wealthy. Today, we’re going to demystify a part of the energy world that most investors have heard about, but very few truly understand: minerals, royalties, and non-operated working interests.
My guest is Tim Pawul, one of the clearest voices in the energy alternative investment world. And today’s episode is a masterclass in how sophisticated investors can access oil and gas without swinging for the fences. We unpack the macro tailwinds shaping the next decade, and Tim breaks down how minerals, royalties, and non-operating working interests actually work, what the cash flow curves look like, and the key filters investors should use when evaluating managers, risk, tax efficiency, and portfolio fit.
If you’ve never allocated to energy, or you’ve only thought about it through public stocks, this conversation will open up an entirely different playbook. And now, onto the show.
Tim, welcome to the show.
Dave, thanks for having me.
Awesome to have you on today and really looking forward to our discussion to help educate investors on investing in this special sector in energy, some of your experiences there, how that’s going, what people should really look for, and how it can work in their own wealth strategy. So why don’t we kick things off and tell us how you got here today.
Sure thing. Again, thanks for having me. I’m based in Houston, Texas, so call it the de facto headquarters of oil and gas globally. When I graduated from Rice University about 15 years ago, I got my first job, and it happened to be in oil and gas, not by design. I then built a career around it since then as it pertains to my specialty and expertise today, which is oil and gas, mineral rights, royalty interests, and non-working interests.
I started a merchant bank about five years ago that specializes in those. Over the years, I’ve become kind of the leading thought leader and expert for those asset classes. And really, the reason I’m in the position I’m in today is just right place, right time, about 13 or 14 years ago. I’ll get into later in the episode exactly what oil and gas mineral rights are and what non-working interests are.
But just as a broader scope, these asset classes have existed since oil and gas has existed for a couple hundred years in the U.S. What’s very interesting about them is the institutionalization of them is very, very recent. So I think as an investor, when you can get into something that is relatively new or burgeoning, but the industry behind it is hundreds of years old, is quite unique, right?
And the reason the quote-unquote institutionalization of these asset classes is relatively new is really because of technology innovation. For the longest time, oil and gas wells were drilled vertically. Think about having a layer cake and poking a straw directly straight down. The different layers of the cake—chocolate, vanilla, or strawberry—represent different geologic formations that have more or less oil and gas trapped in them.
The traditional technology was to drill vertically, and along the way, all the way down, capture the oil and gas as you went deeper and deeper. There’s something called source rock, which is a lot thinner and has less porosity and less permeability, meaning the oil and gas in the ground doesn’t travel naturally as easily. Think of a sponge versus a piece of coral. There are little holes in both, but coral is harder and more like a rock-type formation.
If you were to pour a liquid like oil into a piece of hardened coral versus a sponge, that oil would disperse into the sponge a lot easier. It has more porosity. For that reason, the source rock, where most of the oil and gas sits, would seep into other formations over time. You would drill into those formations because they were easier to access cost-wise.
But around 2008, what some folks have heard referred to as the shale revolution, unconventional drilling, or horizontal drilling—all meaning the same thing—came into play. Very simply put, that vertical straw now bends horizontally and runs along the source rock, extracting the oil and gas in place instead of bits and pieces. This is technically complex and expensive, but technology continues to improve. The reason this matters is that the amount of production a well can capture is significantly higher.
In particular, the cash flow profile, speaking more in financial terms, is very front-end loaded. An unconventional oil and gas well comes online with very high production rates. Picture a graph where time zero starts at high production on the vertical axis, and for about 18 to 24 months it produces at those high volumes. Then it drops off sharply and enters a long tail of production for the next 30 years.
Imagine if 40, 50, or 60 percent of the reserves are extracted in that initial 18 to 24 months. From an investor standpoint, you’re recouping a large portion of a 30-year well’s cash flow in just two years. That front-loaded yield nature makes institutional investors very interested.
These wells also cost anywhere from $8 to $15 million each, whereas vertical wells cost much less. The scale of capital required, combined with the front-loaded yield, made institutions far more interested in oil and gas because they could achieve private equity-like returns at scale.
Circling back to my space, which is minerals, royalties, and non-ops, these were traditionally much smaller in scale. For the reasons I just described, institutions could now play in these sub-asset classes instead of just drilling directly or investing in companies like Chevron or Exxon. Around 2012 or 2013, when I started exploring the mineral space, it wasn’t really a space—it was like a half a dozen companies.
It wasn’t a space; it was like a half a dozen companies. But the first pure-play, publicly traded royalty companies IPO’d in 2014: Viper Energy Partners out of Diamondback in the Permian in the U.S., and they’re listed on NASDAQ. And then PrairieSky Royalty spun out of what was then in Canada.
And since 2014, this was very classic. You look at a balance sheet of a publicly traded company, and there are certain assets not being valued by investors, but when spun out, they’re valued more highly. This is an example of that. These royalty assets were spun out of these publics, they created their own public entities, and now the publicly traded mineral royalty space has been born.
And then in the years prior to that, KKR and Kane Anderson and NGP and Apollo and all the major private equity funds in oil and gas started to back teams to go and aggregate these interests privately. So in this time frame, I started to go around and meet with the CEOs and ask them, “Hey, who backs you? How big are you? What’s your structure? What basins are you buying? What’s your strategy?” And quite frankly, Dave, I didn’t have a plan. It was just an interesting new kind of shiny object in the capital markets.
At the time, I was working for an investor relations platform called Energy Council that Blackstone owns. So my job was to meet with investors, both debt and equity, and management teams of upstream companies, and just kind of figure out what’s going on, where the money’s going. That was my job. So I was just snooping around, and the more I talked to these companies, the more interesting it became. The more questions I asked in every meeting, the more educated I became, and the conversations got a little bit more thoughtful, a little more nuanced. And then the next year, a dozen more companies would pop up in the space, and then the next year, another two dozen companies would pop up.
And just unbeknownst to me at the time, along the journey, a cottage industry formed in the mineral space. And I became known as the guy who knows what everyone’s doing. Now, whether that’s true or not, enough people believe it. You get enough referrals and inbounds, and it starts to become true at some point.
So I’m very blessed and lucky that I was kind of right place, right time and just stumbled upon it. But over the last 13 or 14 years, I’ve had conversations with pretty much every single player in the space. And I place capital into funds, I work the asset side, I invest in things personally, and I host all the major networking events in the space.
I have my minerals and royalties podcasts. So I present. I’ve created this kind of machine, this platform that keeps me on the forefront of what everyone’s doing—new groups and existing groups and deal flow and investment interest, investor sentiment, and all that.
Which is why five years ago, I kind of looked around in the middle of COVID and said, “Hey, there’s something here. I’m onto something here. I want to keep doing this, but have more targeted focus instead of focusing on all things oil and gas.” And in 2021, non-op started to form its own little cottage industry as well. It was the same exact story as minerals from 2012, 2013.
It was the same exact thing. It was just a little later. And I looked around and said, “God, I’ve seen this movie before.” And minerals and non-op, while they’re different, are very similar in that they’re non-control assets. You can scale them accretively without adding people and resources, and they both have really attractive risk-adjusted returns. They’re a good one-two punch because they both have their own benefits around yield and tax efficiency, et cetera.
So I expanded my platform to cover non-op as well. And the reason non-op started to form its own little cottage industry was a product of two things. It was ESG pushing a lot of traditional capital out of the space for hydrocarbons. Folks like endowments and pensions, who may have stakeholder bases that are politically sensitive to investing in traditional hydrocarbons.
And then on the debt side, a lot of European and Canadian banks said, “We’re no longer doing hydrocarbon investing in our portfolio.” So to the tune of billions of dollars of debt and equity capital got sucked out of the space around 2017, 2018. And you’ve got to love capitalism—when there’s a need, capitalists will always find a way to solve it.
So private credit funds started to get raised around oil and gas, and then non-op funds on the equity side. And along the way, in the evolution of unconventional drilling and unconventional technology innovation, companies got better and better and better. We’re now in manufacturing mode as an industry. The science, the experimentation, and the risk of drilling a commercial well are far lower than they’ve ever been historically speaking.
It really is more of a statistics-type play. So the single-well economics of investing into a single well as a non-operated working interest owner—which is essentially a minority participant on the equity side of a well—started to become really attractive around 2020 onwards.
So that, along with the capital need, formed a cottage industry around non-op, with non-op funds on the equity side, non-op credit funds, and the whole ecosystem needed to fill that capital void. Now, for everyone listening, I think what’s really interesting is oil and gas is very capital intensive, and oil and gas wells decline over time. So you need to drill new oil and gas wells to replace that decline in production.
Whether it’s AI data centers or a growing world population or increasing GDP in countries, the world is more and more energy-intensive every day. And that capital glut we faced, with all that debt and equity coming out of the market, creates a really compelling opportunity for investors to fill that void and get attractive returns.
What I always tell folks is sometimes they say, “Well, Tim, are we too late to the game? If that was a 2020, 2021 phenomenon, it’s 2025, 2026 now. Did we miss the window of opportunity?” And I always say, “Hey, listen, you might in your family office circles be talking about this a lot more, but a typical family office check might be $1 to $10 million, and a typical endowment or pension check might be $50 to $500 million.”
So it takes a lot of family offices to fill the shoes of a large institution that’s no longer playing in the space. So while it’s becoming more in vogue in the family office world, there’s still a capital deficit for oil and gas drilling in the U.S., and that presents a phenomenal opportunity.
So I rambled there for a little bit, Dave. I’ll pause for any questions.
Yeah, over to you.
Sometimes they say well, Tim, are we too late to the game?.. I just think… there’s still a capital deficit… and that presents a phenomenal opportunity.
Yeah, no, that was excellent, Tim. Really appreciate that overview. What I’d like to do, because we have a lot of investors listening who’ve probably never invested in the energy space, is two things next. Let’s zoom out and talk a little bit about macroeconomic fundamentals. Right now, we have the demand in AI growing and everything, but we typically like to invest in sectors where we know where the puck is going for the next decade or two or three. How can we be at the right place at the right time?
So let’s talk about macroeconomic fundamentals first, and then let’s zoom in more specifically on what you’re doing around minerals and royalties.
The non-op working interest, and actually talk about that from an investor perspective. What does that look like? What are they investing in? And how does that actually work?
Well, let’s look at it from a macro perspective. Let’s look at it from a commodity viewpoint, and that’s oil pricing and gas pricing. Today, we’re currently in a little bit of a bearish environment for oil. Let’s call it—I haven’t looked at it this morning—but let’s call it around $60 a barrel is where WTI is.
When you look at historical pricing, you can say, okay, traditionally certain break-evens for operators to be incentivized to drill wells and make money might be at $50 a barrel or $40 or $60 or whatever. When you factor in inflation, $60 a barrel today is almost like $40 or $50 a barrel ten years ago. So when you look at where we’re at, just in the context of commodity cycles going up and down, we’re at a pretty low oil price right now. Now, no one can predict where oil prices are going.
If someone says they know where they’re going, they’re full of shit. Everyone’s got their models and their signals, but you just don’t know. And this is why commodity pricing is so volatile. But in general, one thing that’s tried and true is it goes up and it goes down, and it never stays at any of the peaks or the troughs forever.
So when you’re investing in the space, I’ll focus on minerals first. It’s a tremendous time to buy minerals that are oil-weighted because the best way to make a return on mineral investments is to buy undeveloped minerals. Typically, there’s a two- to five-year time horizon before those start to get developed and become producing income assets. So the oil price today—while you’re not going to be extracting $60 a barrel out of the ground today—might be relevant in three to five years, depending on who the seller is.
From emotional reasons as much as economic reasons, the current price today affects the cost basis. So if you’re aggregating, putting Humpty Dumpty back together again, buying these little fragmented interests, and building a portfolio, doing it in an environment where price is a little lower is a really good place to be. Because theoretically, no one knows when oil prices will rebound. But if it’s six or 12 or 24 or 36 months from now, that’s when you’re projecting your minerals to be producing and coming online, so you can ride that wave up, which is really nice.
Geopolitically, these are really, really unique times. There’s a lot going on overseas, and I think any morning we can wake up in a world where Donald Trump’s the president and anything he tweets or says or negotiates can drastically impact what happens to commodity prices.
Especially with a lot of the turmoil going on in the Middle East. Now, I’m not a specialist on each individual event and how it’s going to affect things, but one thing for everyone to take away is you have OPEC, which is a cartel of oil-producing nations that can influence supply-demand dynamics by increasing production or curtailing it in order to lower or increase oil prices.
The U.S. is the most economic producer in the world, and with shale production can ramp up and ramp down production really quickly. So the U.S. is in a very interesting position in the chess game of oil and gas globally. A lot of players in the Middle East, Saudi Arabia, et cetera, could theoretically say, “We’re going to flood the market with production and try to make some fields in the U.S. uneconomic by keeping oil prices down.”
The difference is the implied break-evens for Saudi Arabia are really high because they pay for everything socially with oil revenue. Schools, roads, taxes, and all sorts of things get factored into the economics of producing a barrel of oil in the Middle East. Whereas in the U.S., it’s private industry. It’s companies looking at lifting costs, operating costs, equipment, and transportation costs. It’s strictly the operation itself.
So where someone in the Permian Basin might produce a barrel of oil at break-evens of $45 a barrel, that doesn’t mean Saudi Arabia can do that. It might be $80 a barrel. So when you see headlines about OPEC opening up supply and flooding the market and oil prices dropping, history over the last 15 years shows that’s momentary. They can’t sustain lower prices for extended periods of time. They lose too much money.
This is up for interpretation, but let’s say $75 to $90 a barrel is really where OPEC wants oil prices. The U.S. can be economic in a lot of areas at $50 a barrel and above, but everyone makes more money at higher prices. Wanting oil to be in that $75 to $90 range feels like a median or mean that makes sense in supply, demand, and volatility.
When prices spike to $100, $110, or $120 a barrel, there are usually geopolitical supply shocks that lead to that, but it will revert back down to that $75 to $90 range. And when it’s low, same thing—it’s going to rebound. So in the context of buying undeveloped minerals and betting on the next two to five years, this feels like a really good time right now.
When you’re a non-working interest owner, most strategies are participating in drilling right now, today. There isn’t that development timing risk. There are strategies that do that, but if you think about the bell curve of strategies, the meat of the bell curve is focusing on drilling. That’s where you get the tax benefits, which we’ll talk about in a little bit. And that’s where you have 100 percent certainty that your dollars are going to drilling right now, not waiting two or three years, or maybe forever.
The other benefit people like is getting cash really quickly. Because of that front-loaded yield concept I talked about earlier, you pull in a lot of cash very quickly. So for anyone looking for tax-efficient and yield-oriented strategies, non-op is really attractive for that reason. Very good IRRs.
But in an oil price environment like today, the pie of investable opportunities that are economic starts to shrink. Certain basins, tier-two areas, or extension areas of plays that need $65, $70, or $75 a barrel to break even start to get tabled by operators. So if you’re a fund looking at non-operated working interests, the pool of opportunities you want to underwrite shrinks. There are fewer tier-one opportunities with break-evens at $45 or $50 a barrel.
That means competition can be higher. The same amount of dollars is chasing fewer opportunities, which can increase cost basis and compress returns. Oil prices can rebound, and this is why folks have investment periods and cost-average into markets. You pick your points in time to build portfolios. That’s the oil side.
On the gas side, there are a lot of tailwinds. I think it’s a pretty bullish gas environment. Gas has been living in the $3 to $4 per MCF range for quite some time. There are a lot of positive tailwinds coming, including LNG facilities on the Gulf Coast in Texas and Louisiana scheduled to come online over the next few years.
For anyone who doesn’t know what that means, think about supply and demand. You have massive increases in demand coming into the market almost overnight. That incentivizes more production and more supply. There will be periods where supply can’t catch up because of infrastructure lags—pipelines aren’t built yet, or the industry needs time to respond. So you could see periods of $5 or $6 per MCF gas in the coming years.
I don’t think that’s sustainable personally. Just my view. I think $3 to $3.50, maybe closer to $4, is the equivalent of $75 to $90 oil. That feels like a healthy range. When it dips below $3 or $2 per MCF, a lot of things become economically challenged. But that $3 to $4 range feels about right from a producer standpoint in the U.S.
If I’m Chesapeake Energy drilling natural gas inventory, I can compete globally with any gas field in the world at $3 to $4 per MCF. When prices rise above that, places like Australia or Qatar start to become more competitive once you factor in transport costs. Prices can spike due to shocks like the Ukraine war, when Russian gas was effectively removed from the system overnight.
That led to a huge spike in prices in 2021. It can happen. But prices go up, they go down, and they revert to the mean. That $3 to $4 per MCF range is where I think gas comfortably lives.
One wild card over the last two to three years has been data center development and the amount of energy these data centers consume. The systemic shift in behavior around AI tools like ChatGPT and Grok is significant. They say a Google search is ten times less energy-intensive than a ChatGPT search.
And how many more searches are we doing with ChatGPT because of the ease of it? I always joke around my 9-year-old and 10-year-old kids are using these tools where they weren’t using Google before, but it’s just because of the ease of use. So I think it’s exponential energy usage, and natural gas becomes the most attractive thing to power these data centers through natural gas power plants because of the 24/7 reliability and the cheap cost and also the relative ESG kind of clean use of energy type profile that natural gas has. So when you look at forecasting projects over the last decade for natural gas, it’s just technology innovation. It’s so hard to predict where it’s going to come from. But if you’re a minerals investor or an operator or whatever and you’re making decade-long bets on macro trends, imagine, you know, a 10–15% increase in demand coming out of nowhere. I mean, it’s wild. It’s not like, oh, we’re going to get a little bit more efficient or there’s going to be, you know, Exmoor LNG plants built. These are known factors affecting supply and demand. Just a brand-new category, very, very cool.
And what becomes really interesting around not only the increased demand, but it’s just how that enters the market. And there’s a concept called behind-gate projects. So instead of needing pipelines and transmission to connect to an electrical grid, you’re having a lot of projects build power plants kind of on site to feed directly to the data center and the natural gas feedstock, if you may, in that ecosystem. Those kind of offtake contracts are being discussed right now. And so now you have not only increased demand, but you have what’s called in-basin demand. So you don’t have to worry about major infrastructure being built to get this gas to these facilities. You can have these little pockets that are kind of self-fulfilling. Right. Because the electrical grids all over the country are being completely overwhelmed and it’s going to lead to surges in pricing if it hasn’t already in a lot of areas, rolling blackouts.
And then the regulatory side is, there’s different states that it’s easier or harder to work in from a regulatory standpoint. But regardless, especially if you’re going across state lines, building any type of major pipeline or electrical transmission infrastructure takes a lot of regulatory approval, a lot of hurdles to jump through. It’s big dollars. And it takes years and years and years. And so these behind-gate projects can kind of skip a couple of those layers of friction. And they’re typically smaller in terms of scale than a transmission line project. Right. But nonetheless, it gives a path to increased demand in a shorter period of time over the next five years.
So these data centers can come online. So really interesting time to be in natural gas. You know, the two main basins that are pure dry gas are Marcellus and the Utica up in the Northeast, so Ohio, West Virginia, Pennsylvania, and then East Texas and Louisiana, which is called the Haynesville. And if you’re in these areas right now and you own these assets, minerals or working interest, very, very attractive. Right. The prices are healthy, economics are good today, and there’s a lot of tailwinds to say prices could go up and volumes could go up here in the next five years. So that’s a good place to be. So I’ll take a pause there on the macro side if you have any questions or things you hear from your investors.
Happy to opine on them, but it’s an interesting time for sure.
Yeah, no, that was a helpful overview. What do you think in terms of what is the right fit for an investor? Right. If an investor has not allocated any type of energy into their portfolio yet, what is the right fit for someone to say, hey, I should consider some type of investment in energy? You know, can you explain some of the parameters?
Sure. So my opinion on what’s right and wrong is really the decision for my wife and I to make with our financial advisor. Right. Because as I say that tongue in cheek, every investor has different objectives that they are trying to meet for their portfolio. So I’ll talk about the performance of the asset class generally and kind of the ranges of returns, and then I’ll talk into the different nuances and how it’ll fit different types of investors based on where they’re at in their investment journey.
This is what I do, Dave, is I’m all over the country all the time building relationships with family offices and registered investment advisors and just trying to understand their investment criteria first, educate them on the asset classes in parallel to that, and then backing into the right strategies. Instead of saying this strategy is good for you, it’s really what are you looking for: income? Are you looking for tax efficiency? Do you really want ROI growth long term and compounding your equity dollar? Do you want more IRR-driven strategies? You know, are you worried about liquidity or you’re okay to lock your money up? All these—I ask a series of questions, and based on the feedback I get from those questions really points you in the direction of what kinds of teams they should partner up with. But I guess holistically speaking, I’m a big proponent, especially if you’ve never invested in oil and gas and you don’t have expertise, a big proponent in saddling up with the right jockey.
There are major teams who have been doing this for well over a decade. They have multiple fund track records, they have good GP alignment, and they deliver great risk-adjusted returns. And they all have their own little secret sauce in their way of doing things. But I think it’s really important to saddle up with an expert that’s in the industry, that’s looking at deals every day, that has technology stacks built out, that has proprietary data, a lot of intel, et cetera, et cetera. Right. And why is it important? Not only because they’re sector experts, it’s because they’re cost averaging to the market over an investment period. They’re creating diversification. And I think one of the challenges historically, if you’re going to invest into oil and gas projects and you want the tax benefits of working interest, right, you have to get the off-the-active-income offset, you have to go and direct into a project.
And so there’s immense concentration risk in that, and you might be going, passing the hat around to go into three wells, and the investment could turn out great. But if there’s cost overruns on those three wells or the completion is delayed a little bit or commodity prices go the wrong way on you, I mean, that return on that investment could be in deep trouble. Right, but everyone knows who’s investing here. This is why the S&P 500 is what it is. I mean, when you do index investing, statistical diversification just lowers your risk. Right. Of volatility, especially in asset classes that are backed by oil and gas commodities. So these managers are going to know how to pivot when conditions in the industry go up and down.
They’re going to know where to find opportunity. They’re going to know how to professionally underwrite to make sure you’re getting at the right cost basis. They’ll be back-solving for returns that the funds need. They’re going to be able to leverage things like cheaper cost of debt if there’s leverage on the strategy, using hedging to lock in downside protection. And then of course getting you in multiple basins, under multiple operators, multiple commodities, lots and lots of wells. So you’re statistically protected against anything going wrong in an individual well. So I’ll just say that I really think it’s prudent to not try to go in and Wildcat yourself, but to partner up with some really good managers, and there are a lot of them in the space.
Second, just kind of holistically, what do the returns look like? Right. So in minerals, what are minerals? The funds you would invest into have a deeded interest in the mineral. Right. This is a subsurface estate. It’s just like real estate, but it’s underground. That’s the simplest way to think about it. And from an investment perspective, for anyone who’s familiar with real estate, it’s very similar to a triple-net lease. So the one really appealing thing about mineral rights is you don’t have any ongoing operating costs or Capex.
So you pay, you invest into it one time, you own it into perpetuity unless you decide to sell, can’t go bankrupt, it can’t be taken from you, unless you lever it and violate the debt covenants and the bank takes it. But for the most part, you know, it’s got bankruptcy protection. And if there’s a Covid period, right, where the economy goes upside down or oil prices go super low or gas prices go super low, you wait. Nothing’s going to be taken away, you’re not going to lose it. You just wait for development to come back and prices to come back. And so minerals are really compelling for that reason. There’s IRR risk in kind of the development timing of your asset, but the preservation of value on your return of equity invested is pretty strong. Typically speaking, funds that are five- to seven-year terms are kicking out 2x net MOIC to investors, and they’re delivering high teens to low 20s IRRs. So they’re delivering high teens to low 20s net IRRs on five- to seven-year fund terms.
If you get into a strategy that’s closer to 10 years or maybe a 10-plus-2, those strategies will be in different kinds of basins with a different investment thesis. But you should be expecting close to a 3x net MOIC on that. And typically, kind of a blended high teens, maybe 20% IRR. So risk-adjusted, really attractive. Right? For what it is, it’s income-oriented. You don’t ever have to worry about ongoing Capex or Opex. And on that point, in an environment that’s inflationary, like we’ve experienced the last 3, 4 years, minerals exposure gives you a hedge on inflation. And so inflation is a complex formula, right? There’s a lot of factors that affect inflation. But just very simply put, here’s a scenario for everyone to kind of think about.
If a barrel of oil is $80, right, and I’m a 10% royalty owner, what does that mean? I get 10% off the top of the revenue before anything else gets paid, right? So in the capital stack, I’m number one. So $80 a barrel, I’m a royalty owner, I get eight bucks right off a one barrel produced. Now that operator, let’s call it Exxon, has operating costs of $50 a barrel. And in that scenario, the 80 minus 50, their operating profit is $30 a barrel, right? Let’s go to scenario B, which we’ll call the inflationary scenario. Steel, people, frat crews, rigs, just sand, water, chemicals, everything that goes into drilling and completing and operating all gas wells, it goes up because it’s inflationary. And just like we go to the grocery store and eggs are more expensive and bread’s more expensive, same thing happens in the oil and gas supply chain. And now let’s say oil is still 80 bucks a barrel, but now Exxon has to pay $60 a barrel to extract it, right? 80 minus 60, they make a $20 profit, operating profit.
So their operating profit goes down $10 a barrel. But I still have a 10% royalty on $80 a barrel. I’m still making 8 bucks. And so I’m not exposed to rising costs. And as… So that’s an example of how minerals and royalties provide an inflation hedge. You know, traditionally speaking, if you go back historically looking at inflationary periods and commodity prices, commodity prices usually, they have upward pressure in inflationary periods. So more times than not, gas and oil prices will go up in inflationary environments to reflect kind of those rising costs that I just mentioned.
So now not only are you protected against rising costs, but you’re also typically benefiting from rising commodities. So let’s just say, and that scenario A and B that I just painted out, what if in scenario B oil goes up to 90 and the costs go up to 60, that operating profit’s still 30 for the operator, but now I’m making nine bucks a barrel because, you know, 10% times 90. So really, really attractive there. You know, the other thing too around minerals is you typically don’t have any type of debt used in these strategies. If there is debt, it’s very, very modest, typically just to maybe juice IRRs, you know, a point or two. But for the most part, you know, funds and investors that are in minerals, they want the commodity exposure, right? And then without having debt, you can hold for the long term and not worry about, you know, interest payments kind of digging into your returns. So with that being said, you know, let’s juxtapose it against real estate, which is a very levered asset class in interest. High interest rate environments like we’re in today, minerals become a great complement to real estate because they’re kicking out, you know, I would argue risk-adjusted to real estate.
Higher returns, there’s more volatility, which is why the returns are higher. But they’re all equity returns. So if you’re caught on the wrong side of a credit cycle in real estate and you’re over-levered, you know, the investment could be in jeopardy or just the returns, you know, they get compressed massively. So some of the things that are really attractive, and again, I think if you’re comfortable with doubling your money or two to three times your money in a five- to ten-year period and delivering kind of high teens to low 20s net IRRs, minerals and royalties are a great asset class, right? And they offer that inflation hedge, and it’s a great offset to kind of any debt-heavy asset class like real estate. Switching gears a little bit to non-op working interests. One of the major attractions to investing in non-op is folks looking for tax efficiencies. About 100 years ago, the IRS implemented something in the tax code called intangible drilling costs. Basically, you know, 100-plus years ago oil and gas drilling was extremely risky.
And so theoretical example, one of every ten wells would strike oil and gas, the other nine would be dry holes and they would lose money. Extremely risky business. But for energy security and in order to keep, you know, oil and gas prices down domestically in the U.S., IRS now has to incentivize investors to take that risk. And they do that in the form of IDCs, which enables you to offset the cost of drilling a well in that calendar year as a loss against your income. That’s been in the tax code for 100-plus years. But the industry, as I mentioned earlier in the episode, has technologically evolved, and now as it pertains to shale investing in the unconventional space, is in manufacturing mode. So that risk is not there.
It’s not even close. Right, there’s risk, but the risk factors are maybe commodity price risk and completion risks, like nuances of the return profile may be 20–30%, not a zero or a hero, right? But you still get to capture the benefit of IDCs. So if you were to participate directly in the drilling of a well and let’s just say you spent a million bucks, you could expect, you know, 90ish percent as a tax loss against your income for that year. So go around, you know, all the investment tools in the space, find me something else that is that tax efficient. And by the way, the asset-level returns are still really attractive right now. Goes back to what we were talking about earlier, Dave, of well, if you were to participate in three wells, there’s a lot of concentration risk there. And so folks who wanted these IDCs and that tax-efficient exposure historically have had to do these very concentrated bets, pooling up some non-op capital and participating in wells. Now you have fund structures out there, they’re called GP flip structures that enable you to actually invest into a fund with a manager that builds a diversified portfolio that uses hedging that underwrites everything, right? That, all the things we talk about, that is a benefit of partnering up with a good jockey.
But the way it’s structured enables you to go into the GP, initially capture the tax benefit, and then revert to being an LP for the remainder of the cash flow. So you get the best of both worlds. You get the diversified portfolio, professional manager, good asset-level returns, and you get the tax benefit. So there are a couple of groups in the space that do that structure that I particularly like. Lower fees, good investor alignment. But if tax efficiency is what you’re aiming for as an investor, very, very interesting to look at that kind of structure. Right.
If tax efficiency isn’t the number one thing on your plate, non-op investing is really attractive as well for a couple reasons. One, you typically participate in the drilling today, and so you know you’re going to have cash flow coming in the next three to six months for the most part. So incredibly front-loaded, you know, cash flow profile in these types of investments, and it depends on what you’re trying to achieve, right? If you’re saying, hey, I want to participate in this, I think I feel comfortable with the management team and kind of where commodity prices are and what the opportunity says in the market. I want to invest in this because I like the income. So you might have a strategy that hedges away all the downside risk. They don’t reinvest anything, they don’t use debt, and they just distribute the cash flow. It’s an income product, right? Something like that will deliver typically, you know, one and a half to two times your money and, you know, 20% IRR net to the investor.
Then as you go along, in the barbell strategy, as you go further to the right in risk profile, you have groups that reinvest cash flow, groups that lever the cash flow and then reinvest debt proceeds, groups that use varying levels of hedging to leave upside in pricing. And so if you go to the further right-hand side of the risk spectrum in non-op, you could be achieving MOIC and 30-plus IRRs. So all the strategies in their own right make sense for the right people. But that’s kind of the general return profile. So I would say non-op can deliver higher returns than minerals. There is cost exposure though, right? So there is more inherent risk in a non-op strategy versus minerals because you’re participating in drilling CAPEX, you’re participating in OPEX going forward.
But again, if you get with the right team who’s doing things the right way and protecting you on the downside with the levers they have, like hedging and cost averaging and all that statistical diversification with number of wellbores, etc., I think you’re in a really good spot. Right. So that’s kind of the general return profiles and the different factors at play there that are interesting. You know, a couple other things to note. Folks will be familiar on the equipment side of depreciation that you can kind of write off the value of an asset over time. The oil and gas equivalent of that is called depletion. So general rule of thumb, 15% of cash flow generated from an oil and gas investment can be written off for depletion expense. So you kind of have this built-in ongoing tax efficiency for both minerals and non-op along the way through depletion, which is really nice.
And then because minerals and non-op work interest are real assets, they also qualify for 1031, which most folks don’t know about. So let’s say the 1031 exchange market is $100 billion. I would say 99 of that is in real estate and billions in oil and gas. And there’s no reason why more couldn’t be in oil and gas. I think it’s an education and awareness issue there. There are some 1031 DST funds that are products on RIA platforms that are available. There’s the ability to kind of do it individually into deals. For the most part, you can’t really 1031 into a fund.
There’s some gray area there. I would say if anyone’s interested in that, I could point them in the right direction of some professionals on the tax side and the 1031 side that can walk you through that. But for all intents and purposes, you really want to be going direct on 1031 in order to get your real estate proceeds into minerals assets and vice versa. But just holistically, knowing that they’re 1031 eligible is something people don’t really know. Right. And so if you wanted to play minerals and real estate in your portfolio, and real estate’s really your bag, that’s your expertise. But macro-wise, man, real estate’s really getting kicked in the stomach. Interest rates are super high.
Can’t buy anything attractively. What if you 1031 into minerals and maybe it’s a really good time to buy minerals, and then you recoup the investment return you want from minerals, and then when the real estate market recovers, and that’s your specialty, and you want to go back, you can sell the minerals and you can 1031 back into the real estate. So I think there’s a really good complementary one-two punch. Real estate and all gas, minerals, and non-op have to work hand in hand in a portfolio. I do not here to say stop doing real estate, do only oil, gas, minerals, and non-op, or the opposite of that. But I think for everyone here listening who’s accredited and likely high-net-worth, family office, etc., looking to build a diversified investment portfolio, I think these asset classes deserve a shot to be in the allocation however big that is.
And I spent a lot of time going around the country, like I said, Dave, just spreading that message, getting people educated so that they’re equipped with the knowledge and optionality to allocate to these spaces if they see fit. Right?
Yeah, absolutely, Tim, really appreciate that comprehensive overview. I think that was really helpful for people to really understand breakdown and just the overall context of, you know, the market, you know, where it’s headed, and then how to play in this as an investor. But as you said, you know, there are many benefits to this at multiple levels, and that’s why, you know, we really like this as an asset class. It definitely deserves a place in your allocation somewhere. So Tim, want to be respectful of your time. If people would like to learn more about you or what you’re up to, what is the best place for them to connect?
Sure. So just from if you want to stay connected from afar and just kind of slowly get educated, check out my podcast. It’s called the Minerals and Royalties podcast. It’s on Spotify, Apple, wherever podcasts, or wherever any type of podcast platform you use. If you search my name, Tim Pawul, P-A-W-U-L on LinkedIn, I’m fairly active. Folks kind of use me as the de facto newsletter of the space. I post… My posts are only minerals and non-op, so press releases and announcements from companies and repurposed content. Just every day there’s four or five different things I’m posting around that, and so you can follow that to kind of get plugged into what’s topical and what’s going on. And then would love the opportunity to speak to anyone directly. So you can email me tim@mineralsauthority.com
. My goal is to just educate investors on the asset classes and help guide you on allocating to the space if that’s something you want to do, to look at the right teams and just be informed with the most amount of information to level the playing field. I think the biggest angst investors have going into a new asset class is I…
I don’t know what I don’t know. Are these terms fair? Are these returns industry standard? Is someone screwing me? And why hasn’t this deal been done in Texas? If I live in Connecticut, why is it in Connecticut? And I’ll just say, no one knows more about this space and no one knows the players more than me. My goal is to kind of remove those obstacles and that uncertainty and just present you with information and optionality so that you can transparently know what’s going on and make the best-informed decisions. So, Dave, I really appreciate you having me on and giving me exposure to your audience, and I look forward to continuing to build our relationship here in the near future, and then with anyone else listening. I hope this was informative.
Yeah, really appreciate it, Tim. So much wisdom today. Really appreciate your time and sharing all these insights with everyone. Thanks again.
You bet. Happy Holidays, Dave.
Yeah, you too. Thanks for listening to this episode of Wealth Strategy Secrets. If you’d like to get a free copy of the book, go to holisticwealthstrategy.com. That’s holisticwealthstrategy.com. If you’d like to learn more about upcoming opportunities at Pantheon, please visit pantheoninvest.com. That’s pantheoninvest.com.