Homebuilders today have recently come under public scrutiny for developing property to sale and then severing the mineral rights beneath them at closing. Knowing that the U.S. is in the midst of a natural gas boom, and understanding that states are actively considering allowing drilling in regions not typically thought of as resource-rich areas, the homebuilders hope that by retaining for themselves the rights to the subsurface natural resources they'll massively profit when the energy companies show up to tap into the oil and gas deposits buried beneath the properties.
As the practice comes under greater scrutiny, however, homeowners are only just beginning to realize they've unwittingly signed away rights to a potential fortune. The homebuilders contend that they fully disclose that they're keeping the rights to the resources underneath the homes, but the country's biggest homebuilder, DR Horton (NYSE:DHI), just agreed to return to some homeowners the mineral rights they had signed away.
What the frack?
It's not exactly a secret that the U.S. is awash in natural gas, from the Marcellus Shale region in West Virginia, Pennsylvania, Ohio, and New York to the Bakken formation in the Williston Basin, which spans the Dakotas and Montana. And though controversial, the practice of hydraulic fracturing -- or fracking, as it's more commonly known -- has been one of the primary reasons for the energy industry's growth, allowing oil and gas companies to access deposits that were previously uneconomical to develop.
The Energy Information Administration says that 95% of all the natural gas consumed in the U.S. in 2011 was domestically produced. It's plentiful, cheap, not reliant upon foreign suppliers, and less subject to supply interruption. Production is expected to increase 44% by 2040, growing from 23 trillion cubic feet in 2011 to 33.1 trillion cubic feet. We have so much natural gas, in fact, that a company like Cheniere Energy has been able to build export facilities to sell gas around the world.
According to a new study by the Environment Florida Research & Policy Center, fracking is operational in 17 states, and the industry is pushing to expand the process from coast to coast. Florida is also actively considering permitting the use of fracking, and this boom beyond the borders of traditional oil-patch states has led homebuilders to realize that they're sitting on a veritable gold mine of opportunity. They can continue building houses for sale, but hoard the rights to whatever riches are trapped beneath the surface; when the ability to exploit these resources is permitted, then they'll be able to sell or lease the rights to oil and gas companies at tremendous profit.
The ties that bind
When the natural gas boom came to the Bakken, landowners suddenly found themselves sitting on a windfall. While there were those who realized early on the potential for oil and gas drilling and bought the rights from their neighbors and now are reaping returns in the millions of dollars, many more still collect royalty checks totaling tens of thousands of dollars per month. The New York Times reported in 2011 that one county in North Dakota in particular saw a 50% increase in median income over the last decade.
Severing mineral rights from the surface property is actually not uncommon (or illegal), and just because you don't own the rights beneath your house doesn't mean that Exxon can one day show up at your door saying it wants to erect an oil rig next to your garage. Rather, through techniques like horizontal drilling -- another of the industry's advances that's allowed oil and gas companies access to rich deposits -- you might never even know someone was drilling thousands of feet below your property.
However, in states that are off the beaten path of energy production, severing minerals rights is a far less common practice. Homeowners who bought properties from DR Horton, Ryland Homes (NYSE:RYL), Pulte Homes (NYSE:PHM), and other developers are shocked to learn they signed away the rights when they closed on their homes.
According to an October special report (link opens a PDF) by Reuters, while DR Horton is perhaps the biggest practitioner of the policy, others make regular use of it too. Beazer Homes (NYSE:BZH) says that it typically severs mineral rights in the Dallas-Fort Worth area, but wouldn't say how extensive the practice was elsewhere. Ryland also would not comment on the extent to which it severs mineral rights from the homes it builds. While Pulte acknowledges it does do so, it says that the practice is not material to its finances, though it is valued at more than zero.
Who's the boss?
Now, however, state attorneys general are investigating the practice. DR Horton maintains that it discloses the practice up front with homebuyers (who may now be exercising selective recall because of the potential windfall they can get), but it has agreed to restore the rights to homeowners free of charge in North Carolina and Florida, yet has no intention of revisiting the matter elsewhere.
There's a reason the saying "buyer beware" holds true through the ages -- you should always read contracts before signing.
Fool contributor Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.