EXECUTIVE SUMMARY
Discounting of Oil and Gas Income and Section 23.175 of the Texas Property Tax Code

The development of a series of discount rates for the purpose of appraising oil and gas properties for property tax purposes, although frequently discussed, rarely deals with the distortion created when commodity price modeling is considered.

Most important is when Article VIII, Sec. 1, (a) and (b), and Sec. 20 of the Texas Constitution, potentially conflict with Sec. 23.175 of the Texas property Tax Code.

In order for common ground concerning discount rate to be achieved, differences in price modeling between participants must be considered. Methods for choosing a discount rate that are regularly considered are:

  1. Producers and market participants
    1. Cost of Capital plus return
    2. Like properties in area of interest (Market)
  2. Consultants and appraisers
    1. Like properties in area of interest (Market)
    2. Capital Asset Pricing Model or CAPM, which is used in the,
    3. Weighted Average Cost Of Capital or WACC, and
    4. Stock and Debt

The cost of capital plus return may be used to define discount rate. In this sense it speaks to the requirements of the participant. It does not speak to the market. It is axiomatic that one participant’s cost of capital plus return may be and usually is different than that of other participants seeking to acquire a particular oil or gas property. A superior position regarding the cost of capital places the beneficiary in an advantageous position considering his or her competition. This superior capital position will not guarantee success in the market place. The competition may be willing to accept more risk in hopes of greater return, particularly in the face of low supply and high demand.

Similarly, a participant may be in a superior position with their cost of operation due to company or corporate structure. And, there are likely to be differing views as to the price of the commodity to be produced.

The appraiser in the property tax field is an observer of these interactions and their effect on the oil and gas properties he or she is charged to appraise. One observation of particular interest is commodity price modeling and its effect on discount rate. Of special interest is the mandated oil and gas price model required in Sec. 23.175 of the Texas Property Tax Code. We will not discuss the merits of Sec. 23.175 here, but we must note that it is subject to abuse, misapplication, and/or inequities in light of Article VIII of the Texas Constitution. For that reason, the interaction between price modeling and discount rate must be responsibly examined.