Mineral valuation is a specialised field requiring detailed knowledge of minerals, their methods of extraction and markets, and, like most specialisms, there is a certain mystique attached to it, a situation which is not helped by the general lack of published material on the subject. Because of the degree of specialist knowledge required, the general practice surveyor should be wary of giving detailed advice, but the extent to which minerals impinge upon the economic value of much of the land in this country ensures that many non-specialist practitioners will, at some time, encounter the particular problems affecting the valuation of minerals. Some understanding of the difficulties faced in this area of valuation is therefore essential.
It could be argued that the first of these difficulties is to define precisely what is meant by “minerals”. Though there appears to be no single satisfactory definition, it is possible to start with any one of a number of different legal interpretations. One such definition derives from a case heard in the last century, Hext v Gill [2] 7 Ch 699 which defined the words “mines and minerals” in terms of “what these words meant in the vernacular of the mining world and the commercial world and landowners at the time” — which leaves the matter somewhat open.
Perhaps a more helpful and specific definition to the valuer is that used for taxation purposes and contained within section 29 and Schedule 6 to the 1970 Finance Act; “All minerals and substances in or under land which are ordinarily worked or removed by underground or surface working but excluding water, peat, topsoil and vegetation”. In other words anything of value in the land which can be worked and removed. When just some of the more common minerals worked in this country are considered it becomes evident how extensive a range of materials will be included: clay, china clay, chalk, sand and gravel, limestone, slate, gypsum, salt, iron ore, granite, various building stones and fluorspar, to name but a few.
Having established some means of identifying more precisely what is meant by the term minerals it is necessary to consider just what it is which makes them unique from the valuer’s point of view. Many minerals occur beneath the surface and even those which can be worked from the surface tend to be very difficult to survey accurately. Ordinarily, other forms of property can be seen and inspection will reveal exactly what is there, whereas minerals are usually concealed so that their quantity and quality can only be assessed by estimation.
As well as this obvious physical difference it is important to recognise important legal distinctions. Minerals can exist as a totally separate legal entity severed and sold separately from the surface in or under which they are contained. Thus the ownership of minerals is not necessarily dependent upon ownership of the surface. Furthermore, the occupation of mineral-bearing land can only occur as the mineral is worked. In other words, the process of working and removing the minerals is actually a process which converts a part of the land into a chattel which can then be sold. Thus a part of the land is being destroyed and can never be used or occupied again in the same way.
Minerals are the outstanding example of a wasting asset and this has considerable implications for the method of valuation used, a matter which will be considered later.
Method of valuation
Unlike most other forms of property, minerals are very difficult to compare. There is of course a vast range of different minerals but even with the same type of mineral there are bound to be differences in quality and quantity which make it very difficult to apply normal methods of valuation by comparison. Usable direct evidence is rarely available. Even where apparently “comparable” sales exist it is always necessary to examine the circumstances of each particular transaction very carefully before applying the results of analysis to a valuation. For example, an operator extracting minerals from a particular site may be so anxious to acquire further nearby or adjoining reserves to supply established plant that he may be prepared to pay a price well in excess of that payable by any other operator. Similarly, an operator may bid for reserves purely to maintain a monopoly position in the supply of a particular mineral. Conversely, it is always necessary to be aware of the not uncommon situation where a landowner will sell, blissfully unaware of the presence of valuable mineral reserves, at a price which reflects little more than the existing use value.
The comparison method, then, is rarely applicable to the valuation of minerals with any degree of accuracy, so the preferred approach will tend to be the investment method. The owner of minerals is in effect giving up a capital asset and will expect to receive, in return, some form of income from the operator who is going to profit from working those minerals. As with any other situation where the investment method is to be used it is necessary to examine the income received by the mineral owner as well as appropriate capitalisation rates, the two major variables involved in arriving at a capital value.
Income from minerals
Conventionally, incomes derived from mineral-bearing land are of three different types: site or surface rent; “certain” rent; and royalty payments. The most important source of mineral income is the royalty. This is usually equated with rent but is a payment based on the output of mineral worked, usually quantified as so much per tonne in the case of bulk minerals, such as sand or limestone, or a percentage of value in the case of the more valuable metalliferous minerals such as tin, lead or copper.
However, operators will often acquire mineral-bearing land with no immediate intention of extracting minerals. It may be a case of holding the land to ensure future continuity of supply or a matter of excluding competing operators. Whatever the reason, this could, if rent were to be based simply on output, affect the income of the landowners. To prevent this and to encourage the operator to work the minerals, thereby maximising the owner’s income flow, it is normal to charge a “certain” rent. Also referred to as the minimum or dead rent, this is a minimum amount charged to the operator, usually on an annual basis, which he will be obliged to pay whether or not minerals are actually worked. This minimum or certain rent is normally offset against the royalty payable in each year. Finally, as the owner of an area of mineralised land will forgo any rental income he would otherwise derive from the land, it is normal to compensate for this by charging the operator a rent to cover the occupation of the surface. This will often be based on the value of the surface, in most cases the agricultural rental value. The payment will normally be calculated to include the area of the mineral deposit and any additional areas required for access to the mineral as well as the site area occupied by processing plant.
Calculation of royalty
In simple terms royalities are usually calculated by reference to the profits made by the operator, utilising principles familiar in the profits method of valuation. This is illustrated in Example 1, which takes the initial selling price of the worked mineral and deducts the operator’s fixed and variable working costs as well as the cost of capital borrowed to finance the operation. The residual amount can then be divided between the operator, as his profit, and the landowner as royalty or rent. The example shows this division being made equally between owner and operator, but this will not always be the case. In fact this sum will be the subject of negotiation and will depend, among other things, on the particular circumstances of the two parties involved, illustrating just how important a detailed knowledge of the nature and costs of the operation will be to the valuer acting for either side.
Example 1: Simple royalty calculation
This example illustrates the calculation of the royalty payment to the owner of a chalk quarry to be let to a mineral operator. The estimated output of the quarry is 25,000 tonnes pa and the market price of chalk is £2 per tonne. The operator will be investing £100,000 in the operation at an interest rate of 12.5% pa. Normal working costs will be £25,000 pa.
Factors affecting value
The first thing to establish prior to valuing an area of mineral-bearing land is the quantity of minerals lying beneath the surface. This is no easy matter, for despite modern and sophisticated techniques of sampling available, the amount of material which can be worked economically can at best only be estimated. If this does not represent problems enough it is also necessary to establish the various physical properties of the mineral, the extent of the deposit, its quality, the nature and thickness of underlying and overlying rock, its geological structure including dip, strike, folding and faulting as well as the existence of underground water and other features which will affect the ease and cost of working as well as safety.
It is also important to establish the chemical properties of the deposit. Limestone deposits, for example, might simply be used to supply material for the aggregate industry but may also include the rarer and more valuable chemical grades used in a variety of industrial processes. Or the material may contain impurities which require screening or washing and thus add to the processing costs.
It is also necessary to consider the market for a mineral. The value of fairly ubiquitous minerals such as sand and gravel varies from £3 per tonne in the South East down to 25p elsewhere, this variation resulting largely from the present high demand from the building industry. How close and accessible is the market? Transportation costs where the market is distant can soon absorb profits in the case of low value, high bulk materials such as roadstone. Are there any other alternative sources of supply? Is the demand for the mineral likely to be subject to change? These are all issues which the valuer must address.
Any property valuation would need to take account of town and country planning and this is certainly true of minerals. In fact, because of the generally obtrusive nature of mineral extraction, planning control is invariably very strict. Planning authorities may well specify the nature and timing of working and make provision for restoration at the end of working. They may also seek to control such matters as the removal of overburden, blasting, methods of transportation, end use, level of output, waste and water disposal as well as limitations on the location and structure of plant. These controls will be especially restrictive in those environmentally sensitive areas such as the national parks which, owing to their particular geological structure, appear to be especially well endowed with mineral deposits. Clearly such restrictions will always have a major bearing on the cost and, therefore, the profitability of working.
Capitalisation rates
Once the likely income from the mineral-bearing land has been established it is necessary to determine the rates at which these incomes should be capitalised. As minerals are a wasting asset it is normal to make provision for a sinking fund to redeem the initial capital outlay and adjust for tax on the accumulation of the sinking fund where appropriate.
Because of the high capital costs of mineral extraction and the high degree of risk and uncertainty involved, capitalisation rates are, not surprisingly, high, with rates ranging from 15% to 25% being by no means unusual. Where the operator is paying a surface rent it is normal to capitalise this at a much lower risk rate as this income is effectively underwritten by the existing use value of the land. Likewise, as the certain rent payable is not subject to the viscissitudes of mineral markets, these are usually capitalised at lower risk rates as shown in Example 2.
Example 2: Simple freehold valuation
A 15-acre chalk quarry is let by the freeholder on a mining lease for a period of 40 years or until the quarry is exhausted (whichever is the sooner). The total chalk content is estimated at 50,000 tonnes/acre and the expected rate of working is 25,000 tonnes pa.
The operator pays a surface rent of £35 per acre and a certain rent of £2,000 pa. The royalty payment has been agreed at 25p per tonne. What is the value of the freehold interest?
It is normal for the operator to take responsibility for the reinstatement of the land where possible, and in such cases it should be remembered that there may be some residual value to be included in the freehold valuation. In the case of quarried sites there will often be further income potential for tipping purposes, and many areas of former sand and gravel extraction are now being utilised for leisure uses and, in some cases, even industrial and retail uses.
Where there is likely to be a valuable end use this can be reflected in the capital valuation by adding in to the computation the future capital value of the site, suitably deferred over the period of working after making allowance for any reinstatement costs.
This brief article gives some indication of the complexity of valuing mineral property. It is not intended to be definitive, in particular the valuer should be aware that there are a number of issues which have not been covered, the use of single rate valuation formulae and the possibility of using discounted cash flow techniques, for example, both of which have been the subject of considerable debate. It is stressed that this is a highly specialised field of valuation and one in which the general practitioner would be well advised to seek expert advice.