WATER TRUSTS V. LEASING

By

Dr. William M. Turner

The scramble for water in Texas resembles the oil and gas boom of the 1920s that made men like John Paul Getty and the Hunts wealthy.   They were the ones who leased Texas for oil and gas.

Today, leasing land for water is spreading like wildfire through Texas and it has the Texas farmer frightened.  Here is why.

THE LEASE

Texas is a common law state.  The surface owner owns everything from the center of the earth to the sun above his property including the water and the oil and gas.  With regard to water, Texas is a right-of-capture state.  That means, if you own the surface you have the absolute right to drill for water and to produce every drop you can manage. 

Now, unlike oil and gas that occur is pools here and there, usable ground-water supplies exist over broad areas.  A farmer that leases land for water is really leasing access to the surface and is surrendering his right to control the surface from which he makes a living.  The water company can drill anywhere and lay pipelines and install tanks and pumping stations anywhere they please

Also, because of long lead times to secure water contracts, obtain financing, condemn right-of-way, and build pipelines and water tanks and pumping stations, the lease must be for a long period of time.  The water lease becomes a future encumbrance on the surface estate.  If a farmer wants to sell his property, the water estate will not pass with it.  What will pass is an encumbrance on the surface over which the surface owner has absolutely no control.

Next, there is the matter of the royalty.  In the oil and gas business, royalties are paid for the well-head value of the oil and gas.  In the water business, there is no well-head value.  There is only the delivered price or strike price as it is called.  The price is set by water utilities and politicians.   Water systems are commonly called enterprise units of government because government makes a lot of money from the sale of water, not the owner of the resource.  The only way to be fair to the owner of the resource is to set the royalty as an add-on percentage of the strike price.

Farmers in an area have a right to be concerned because the withdrawal of ground water from a neighbors property may drain ground water from beneath his property.  So, he has two concerns.  His water table is dropping because of the pumping on the neighbors property.  That will increase his pumping costs and, in an industry where everything is purchased at retail and sold at wholesale, his profit margin is squeezed.  Second, panic tends to set in because the leasing wave may pass him by and leave him out if he doesn't sign up for a something that may leave him out of control of his own property.

Unless the lease specifies how the price of the water will be calculated at the well, it is anyone's guess.  The well head price is probably a "Net Well Head Value."   This is an ambiguous term like "net smelter returns" in the mineral industry.

Here is how it would probably be calculated

Net Well Head Value = (Delivered Wholesale Price to the Buyer) - (Annualized Amortization Cost of Wells, Pipelines, Pumping stations, SCADA System) - (Water Treatment + Maintenance = Power Costs) - ( Administrative + General Overhead) - (Other Costs)

You receive:

Net Well Head Value x 0.10

The Net Well Head Value is most sensitive to what the end user is willing to pay for the "Delivered Wholesale Price" of the water that they then resell and the "Other Costs""

The Lessee can build anything into its cost base that it wants related to the project.  For example, high executive salaries, plush offices, vacation and travel other unrelated business activities and drive the net profit to "0."   Ten percent of "0" is "0"

Furthermore, competition from other sources can result in a low "Delivered Wholesale Price."

The Lessor has no ability to drive the sale price of the water. So the method of determining the well head price must be specified.

Last, and probably not least, is the fact that, unless all leases are required to be unitized (and there is usually no requirement for this in leases), the only people who get a royalty are the farmers whose land is drilled on.  Everyone else has their land encumbered for a long period of time, and perpetually if water is produced from it.

Is there an alternative so that one can be assured of royalty income and leave the land unencumbered and receive 95 percent of the sale price of the water and retain control of the land and the placement of wells?

THE WATER TRUST 

A Water Trust is established pursuant to the law of contract between a creator and land owners by placing their water into the trust.  Trust certificates are issued in proportion to the amount of water (or acreage) that is contributed when it is formed.  This method unitizes all of the productive land at the outset so that all farmers are guaranteed mailbox money no matter when or where water is produced as long as it is produced from land within the trust.

The Water Trust is managed by a Board of Trustees that is comprised of farmers who are trust certificate holders.  The decisions as to where to put the wells and pipelines and water tanks are made by the Board of Trustees.

Under Section 857 of the Internal Revenue Code, a Water Trust, should be treated as a Real Estate Investment Trust and 95 percent of  the net income must be distributed to the trust certificate holders.  The Water Trust can obtain a listing on stock exchanges and markets can be created for the trust certificates.   Such is the case with the Mesabi Trust which was created in the early 1960's and is traded on the New York Stock Exchange under the symbol (MSB).

A Water Trust has a Board of Trustees.  It can establish reasonable salaries and other costs.  It can set the well head price and a buyer can take it or leave it.  In other words,  the issue is who drives the price.   The user or the seller. Under the traditional model it has always been the user driving the price.  This will change and it will become the supplier who sets the price.

To an important player, the Water Trust must be the 800-pound gorilla.   If there is competition from Leased water in an area, it is likely that they will drop the Delivered Wholesale Price to eliminate competition and they will be successful for a while.  This, of course, means that the Lessors  will see very little money.

The Water Trust can afford to hang on until the leased water is fully used.  Unlike the leased land, a Water Trust are no carrying charges and the Water Trust can go dormant until its water is in demand.

The Water Trust gives the farmers considerable say in what happens to their land.  It can also provides liquidity and certain value for their trust certificates.

For assistance in establishing a Water Trust, contact Dr. William M. Turner.