Investing in Minerals
Minerals (real estate below the surface of the earth that produce, or are prospective of producing, crude oil, natural gas and natural gas liquids) are one of the most-ignored alternative investment classes. They have been our best-performing investments over time, and we believe they belong in every well-diversified portfolio.
We have been buying minerals—producing, non-producing, overrides and net profits interests—since 1983. We bought minerals when oil was $15 and when oil was $75. Minerals are a hedge against inflation and geopolitical risk when the price of other assets may suffer.
As we mention frequently, minerals are different from other energy investments because they come without corporate overhead, income taxes and liability for operator accidents. Minerals can produce monthly income from royalties and, on occasion, lease bonuses and sales. Royalty income is partially sheltered from taxes by the percentage depletion deduction. Our ideal holding period is forever, but we have occasionally sold minerals when offered ridiculous sums. That happens more often than one would think.
Supply and Demand Trends for Oil over the Intermediate Term
Put briefly, geopolitical risks are high. The supply from two major oil and gas producers, Venezuela and Iran, is at serious and imminent risk, and there are no new major sources of supply on the horizon. (The most prominent “new” discovery in recent years, the Permian, was discovered almost 100 years ago). The world is not replacing the oil supply through new discoveries at the same rate we are consuming it. Contrary to some reports in the media, the United States is still a net importer of oil.
As the chart below illustrates, China and other Asian countries have growing energy needs. We won’t belabor the arguments we’ve made in previous letters, but India has only 1,100 miles of paved highways. India’s need for asphalt alone, a byproduct of oil, is enormous. China’s cities are among the smoggiest in the world, largely because of coal burning in cooking and electric generation. Until China’s nuclear projects can take up some of the supply, its demand for natural gas in the form of LNG will continue. In the case of both India and China, urbanization will increase the demand for oil and natural gas. Additionally, non-energy demand for oil and natural gas in the form of plastics and fertilizers is usually ignored but is substantial.
Although we buy minerals whenever we find them at the right price, we think now is a particularly good time to buy. Shrinking supply and growing demand suggest higher oil prices over the next few years. Over the next 10 years, oil prices are likely to be volatile as they have been since we started buying in 1983, but supply and demand suggest an upward price trend. In the meantime, minerals will produce regular income, which is always a substantial part of the total return.
Like all investments, oil prices are influenced by supply and demand, but are largely uncorrelated, even negatively correlated, to financial assets like publicly-traded equities and bonds. Today, the prices of real assets like commodities are near an all-time low relative to the prices of financial assets. Ongoing concerns about tariffs on manufactured goods and the increasing reliance on FAANG stocks to prop up the market indexes are the latest threats to the economy. Moreover, the market for mineral interests is relatively small and inefficient. Although oil prices have recovered from their 2014 lows, we are still seeing some bargains.