Proposed Rule on § 9.4031, 34 Tex. Reg. 5753-6066 (Sept. 9, 2011)

8/4/2019 Proposed Rule on 9.4031, 34 Tex. Reg. 5753-6066 (Sept. 9, 2011)

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TITLE 34.PUBLIC FINANCEPart 1. COMPTROLLER OF PUBLIC ACCOUNTSChapter 9. PROPERTY TAX ADMINISTRATION

S ubchapter B . PER FO RM AN CE A UD IT A DM IN ISTR ATIO N34 TAC 9.301T he C om ptroller of P ublic A ccou nts proposes an am endm ent to 9.301, concerning ap praisal district rev iew s.S ubsection (e) is being am ended to change the date fur providing draft reports of review findings andre co nn ne nd atio ns to p ro vid e a dd itio na l time fu r c on du ctin g th e re vie ws and developing reconnnenda tions . Thissu bsectio n is also b ein g am en ded to p ro vid e fu r d eliv ery o f rep orts an d reco rrn nen datio ns b y electro nicpublication.John H elem an, C hief R evenue E stim ator, has determ ined that for the first f ive- year period the rule will be ine f fec t, t here will be no significant revenue im pact on the state or units o flo ca l g ov ermne nt.Mr. H elem an also h as determ ined that fur each year o f the first five y ears the rule is in effect, the public benefitan ticip ated as a resu lt o f en fu rcin g th e ru le will b e b y en han cin g th e p ro ced ures fu r d is sem in atin g ap pra isal d istrictreview s. T he p roposed am endm ent w ould have no fiscal im pact on sm all businesses. T here is no significantanticipated econ om ic cost to individuals w ho are required to com p1y w ith the prop osed rule.C onnnents on the am endm ent m ay be subm itted to D eborah C artw right, D irector, P roperty T ax A ssistanceD ivision, P .O . B ox 13528, A ustin , Texas 78711-3528. C onnnents nrust be received no later than 30 days fromthe date of p ublication of the p roposal in the Texas Register.The am endm ent is proposed under Tax C ode, 5.102(a) w hich allow s the com ptroller to adop t rules to establishp ro ced ures fu r co nd uctin g an d sco rin g rev iew s after co nsu hin g w ith th e co mp tro ller's P ro perty V alu e S tu dyAdvis or y Comm itte e.This s ec tio n im p le m en ts T ax C o de , 5.1 02 (a ).9.301.AppraisaZ District Reviews.(a) D efinitions. T he fullow ing w ords and term s w hen used in this s ub ch ap te r s ha ll h av e th e fo llo w in g m ea nin gsu nle ss th e c on te xt in dic ate s o th erw is e.(1 ) C om ptro ller-- T he T ex as C om ptro ller o f P ub lic A cco un ts o r th e co mp tro lle r's d esig nee.(2 ) D is tric t - - A c ou nty a pp ra is al d is tric t.(3 ) D iv isio n-- T he P ro perty T ax A ssistan ce D iv isio n o f th e O ffice o f th e C om ptro ller o f P ub lic A cco un ts,(4 ) G en era lly a cc ep te d a pp ra is al s ta nd ard s, p ro ce du re s, a nd m e th od olo gy --S ta nd ard s and p ro ce du re s a do pte do r reco rrn nen ded b y th e In tern atio nal A sso ciatio n o f A ssessin g O ffice rs (IA A O) co ncern in g ap praisal,con tract ing , pe rsonnel , and a dm in is tr atio n o f a d v al or em ta xa tio n, and T he Ap pra is al F ou nd atio n's U n ifu rmS ta nd ard s o f P ro fe ss io na l A p pra is al P ra ctic e.


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(5 ) R ev ie w-- T he c om ptro lle r's rev iew o f th e g ov ern an ce o f e ach ap praisal d istric t, ta xp aye r a ssista nc e p ro vid ed ,an d the o perating an d ap praisal stan dards, p ro ced ures, an d m eth od olog y used b y each ap praisal district asrequired by Tax C ode, 5 .102.(6) Score-- T he m easure of p erform an ce in dicated at th e con clu sio n o fa rev iew .(7) Study-- T he property value studies required by G overm nent C ode, 403.302 and T ax C ode, 5.1 O .(8 ) R em ed ia l a ctio n- - A ctiv ities a nd d ecisio ns m ad e b y th e b oa rd o f d irec to rs o f a d istric t th at d em on strateaw are ne ss o f an d c on cern fu r im p lem en tin g th e rev ie w's rec om m en datio ns a nd ac tio ns ta ke n w hich d em o nstra tes ig nif ic an t p ro gr ess tow ard s im p lem en tin g th e r ec omme nd atio ns in a tim e 1y manner ,(b) B ierm ial R eview . A review o f ev ery d istrict sh all be co nd ucted o nce ev ery tw o years according to a sch ed ulein w hich a pp ro xim ate1 y o ne -h alf o f th e d istricts a re su bjec t to rev ie ws e ach y ear. T he c om ptro ller m ay d eterm in eth e sch ed ule o f re view s and assig mn en ts o f d istricts b ased o n co nsid eratio ns w hic h in clu de, b ut a re n ot lim ited to ,th e e ffic ie nt u se o f c omp tro lle r r eso ur ce s and co ord in atio n w ith th e sch ed ule fu r c on du ctin g th e stu dy .

(c) Scope of R eview . The review shall be based on requirem ents of the T ax C ode, com ptro ller rules, o ther law s,a nd g en era 11 ya cc ep te d a pp ra is al s ta nd ard s, p ro ce du re s a nd me th od olo gy . T he d iv isio n sh all d ev elo p q ue stio ns ,co ndu ct ph ysical in spection s of p rop erty and app raisal reco rds, an d use other m etho ds th at are d esign ed tod ete rm i ne c omp lia nc e w it h th es e r equ ir emen ts and to d ev elo p a score. C om pliance w ith 9 .3 001 , 9 .30 02 ,9.3003, and 9.3004 of this title (relatin g to A ppraisal C ard s; T ax M aps; U nifo rm T ax R ecords System ; andA pp raisal R ec ord s o f A ll P ro perty) is m an dato ry and re qu ired to o btain a p assin g sco re.(d) Scores. T he results ofa d istric t rev iew shall be scored at the co nclusion of th e rev iew . S co res shall includ ep ass o r m il d ete nn in atio ns fu r co mp lian ce re qu irem en ts d eem ed m an dato ry b y th e co m ptro ller. A d istrict m ustp ass all m an dato ry com pliance requ irem ents in ord er for a scho ol d istric t to be in co mpliance w ith therequ irem ents ofG overm nent C od e, 40 3.3 01 1(2)(D ). A reco rrn nen datio n shall b e m ade b y the divisio n fur eachin dic atio n o f n on -c omp lia nc e. S co re s fu r o th er re qu irem en ts sh all b e d iv id ed in to th e fu llow in g c ate go rie s:( 1) governance;( 2) ta xp ay er a ss is ta nc e;( 3) d is tr ic t ope ra ti ons ; and(4 ) a pp ra is al s ta nd ard s, p ro ce du re s and methodology.( e) Repo rt ing . The d iv isio n sh all p ro vid e a d raft re po rt o f th e rev ie w fin din gs a nd rec om m en datio ns to th edistrict's ch ief app raiser by S ep tem ber 1 [JtiH :e 1 ] or as so on th ereafter as practicable by U nited States P ostalS ervice first-class m ail or by e- m ail. T he review fo r each district sh all b e com pleted by the d ivisio n n o later thanD ece mb er 3 1. A s so on th erea fte r a s p rac tica ble, th e d iv isio n sh all p ub lish o n th e co m ptro ller's w eb site th ecomptro ll er 's f ind ings and re co rrn ne nd atio ns fu r im p ro vem en t re su ltin g from th e re view . A t o r r ea so na blyp romp tlY a fte r th e f in d in g s and rec om m en datio ns fu r irw ro ve me nt resu ltin g fro m th e rev iew a re p ub lish ed o n th eco mp tro lle r's w eb site. th e co m ptro ller sh all. b y U nited S tate s P osta l S erv ic e first-class m ail o r b ye -m ail. n otifYth e fu llo win g th at th e fin din gs an d re co mm en da tio ns h av e b ee n p ub lish ed : [ th e eem p tffille f sh tll a eftV ef fiyregtlffif, first ela:ss ma :ilte ] t he d is tr ic t's ch ie f appr ai se r and b oa rd o f d ire cto rs and th e su pe rin te nd en t a nd b oa rdo f tru ste es o f e ac h sc ho ol d istric t p artic ip atin g in th e d istr ic t [ th e e emp tffille f's re ee fH ft1 efttia tie ns m f


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( f) C omp1ia nc e w ith r ev iew r ec ommenda tio n s. The district and its b oa rd o f d irec to rs sh all ta ke re med ial actio nre aso na bly d esig ned to e nsu re su bstan tia l co mp lia nc e w ith e ach re co rrn ne nd atio n in th e re view within 1 2 month sfrom the date that the results of the review w ere delivered as required by this section The c omp tr olle r s ha lld eterm in e su bsta ntial c om p lian ce d urin g D ec em be r o f th e ye ar fo llo win g th e ye ar o f th e rev iew . S ub sta ntialc omp lia nc e m a y b e d ete rm in ed ifthe district h as taken rem edial actio n fo r each reco mm en datio n in the review . Ifth e c om ptro ller d ete rm in es th at th e d istric t h as n ot a ch iev ed su bsta ntial c om p 1ia nc e, th e T ex as D ep artm en t o fLicensing and R egu lation shall be notified and prov ided co pies of th e resu hs an d recom m en datio ns o f the reviewwithin 3 0 d ay s o f th e c omp tro lle r's d ete rm in atio nThis agency h ereby certifies th at the p ro po sal h as been rev iew ed b y leg al co un sel and fou nd to be within th ea ge nc y's le ga l a uth ority to a do pt.Filed w ith the O ffice of the S ecretary o f State on A ugu st 2 9,20 11 .TRD-201103488As hl ey Ha rd enGene ra l CO lIDSe lC omptr olle r o f P ub lic A cc ou ntsE arliest p ossib le d ate o f ad op tio n: O cto ber 9 ,2 01 1F or f in th er in fo rm a tio n, p le ase c all: ( 51 2) 4 75 -0 38 7

Subchapter I. V AL ID AT IO N PR OC ED UR ES34 TAC 9.4031The C om ptroller of Public A ccounts proposes an am endm ent to 9 04031, c on ce rn in g th e m a nu al fo r d is co un tin go il an d g as in co me . This se ctio n is b ein g am en ded to im p lem en t S en ate B ill 1 50 5 , 8 2n d L eg islatu re , 2 01 1,effectiv e Ja nu ary 1 , 2 01 2, w hic h c ha ng es th e m ethod to be used in th e a pp raisal o f o il an d gas in place that isappraised by a m ethod that takes in to account the future incom e from the sale of oil or gas to be produced fromth e in te re st. T he sec tio n is a lso b ein g a men ded to sep arate ly id en tify th e a pp en dic es an d to d el ete th e l is t o freferences.

Jo hn H elem an , C hief R ev en ue E stim ato r, h as d eterm in ed th at fo r th e first fiv e-y ear p erio d th e ru le w ill be ine ff ec t, t he re will be n o sig nificant rev en ue im pact on th e state or units o f l oc al gover rn r en t.Mr. H elem an also h as d eterm in ed th at for each year o f the first fiv e y ears the rule is in e ffe ct, th e p ub lic b en ef itan ticip ated a s a re su lt o f e nfo rc in g th e r ul e w il l b e b y im p ro vin g th e a dm in istratio n o f p ro pe rty tax atio n a nd th eap praisal of p ro perties w ith o il and natural g as interest. T he p ro po sed am en dm en t w ould have no fiscal im pacto n sm all b usin esse s. T here is n o sig nific an t an ticip ated e co no mic co st to in div id uals w ho a re req uired to c om plyw ith th e p ropos ed rule.


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C om m ents o n the am en dm en t m ay be su bm itted to D ebo rah C artw rig ht, D irecto r, Pro perty T ax A ssistanceD ivision, P.O . B ox 13528, A ustin, T exas 78711-3528. C om ments nrust be received no later than 30 days fromth e d ate o f p ub lication of th e p ro po sal in th e Texas Register.The am endm ent is proposed under Senate B i111505's am endm ent to T ax C ode, 23.175 w hich requires theco mp tro lle r b y ru le to d ev elo p a nd d istrib ute to eac h a pp raisal o ffice ap pra isa l m an uals th at sp ecify th e fu rn ru 1ato be used in com puting the l imit on the price fur an in terest used in the second through the six th year of anappraisal and th e me thods and p roced ures to d iscou nt futu re in com e fro m the sale o f oil o r g as fro m the in terestto p re se nt v alu e.T he am en dm en t im plem en ts T ax C od e, 23 .1 75 (b ).9.4031.Manualfor Discounting Oil and Gas Income.(a ) The C om ptro ller o f P ub lic A ccou nts ado pts a M anu al fu r D isco un tin g O il and G as Incom e, w ith text asfullows.(b) B asis of the M anual fur Discounting O il and G as Incom e.(1) Property Tax C ode, 23.175, enacted by the 73rd Legislature, 1 99 3, req uires th e c om p tro lle r's o ffic e todevelop and d istrib ute to eac h ap praisal d istrict an ap praisal m an ual th at sp ec ifie s th e m eth od s an d p ro ce du res tocalcu late th e p re sen t v alu e o f o il a nd g as p ro pe rtie s u sin g d isco un ted fin ure in co me . T he 8 2n d L eg isla ttn "e. 2 01 1.am en ded P ro perty T ax C ode. 2 3.1 75 to requ ire the co mptroller's office to specifY the fu rnru1 a to be u sed inc ompu tin g th e l imit o n the p rice fu r an interest used in th e seco nd throug h the sixth year of an ap praisal begin ningw ith th e 2 01 2 tax yea r. T he fo rn ru 1a i s sp ec ified in su bsec tio n (P ) o f this se ctio n (A pp en dix 5 ).(2) Section 2 3.1 75 also directs each app raisal district to u se th e s pe cif ie d m e th od s a nd p ro ce du re s,

(c ) In troduct ion(1 ) This m an ua l ex pla in s th e co nc ep t o f d isco un tin g, th e d isc ou nted ca sh flo w (D C F) eq uatio n, D C F ap praisal,an d three accep tab le techn iqu es fur estim ating a "d iscou nt rate" in the D CF m eth od . T he nu mb ers u sed in th ec al cu la tio n s a re f ur ill us tr at iv e pu rpo se s on ly .(2 ) T he th ree acc ep tab le tec hn iq ues fo r estim atin g d isco un t ra tes are :(A) ma rk et s ur ve ys ;(B) o il a nd g as sa le s a na ly sis; and(C ) w eigh ted average co st of cap ital (WA CC ), also called ''band of inves tment ."(3) T og ether, th ese techn iqu es prov ide a rang e of disco un t rates. T he ap praiser n ru st estim ate the risk fu r eachoil o r g as pro perty to assig n a d iscou nt rate fro m the disco un t rate rang e.( 4) Subsec ti ons C D - (0) of this section (A ppendices 1 - 4) [ The a fJ fJ ef lf lie es ] p ro v id e e xamp le s to i llu str ateD C F a pp raisal, th e W A C C estim atin g te ch niq ue , a stan da rd d ev iatio n an aly sis, and a d esc rip tio n o f p ro pe rtys pec if ic r is k f ac to r s.


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( d) D iscount ing ,(1) B ecause investors prefer irm nediate cash retum s over future cash returns, investors pay less fur future cashflow s--the y "disc ount" them T he am ou nt inv estors d iscou nt th e future cash flow s depends on the length of tim euntil the cash is due, the am ount of risk that the cash will not be tendered when due, and the rate of returnava i1a ble fro m othe r com pa rab ly risky investm ents. T his disco untin g p roc edu re con verts future inc om e to prese ntvalue , usually using ann ual d iscou nt fac tors. T he discoun t fac tor fur e ach su cce ssive y ear de clin es to re flect thereduced value of revenue received in the future. T he appraiser calculates th e pre se nt w orth o f the foreca strevenue stream by m uhiplying the projected net incom e (cash flow ) fur each year by the calculated discountfactor fur that year. These discount factors are derived from the discount rate (also know n as the yield rate), andthe process is known as discounted cash flow (D CF) analysis.(2) T he Internatio nal A ssociation of A ssessing O ffice rs in P ro perty A ppraisal an d A ssessm ent A dm inistration(1990) defines "discount rate" as: 'T he rate of return on investm ent; the rate an investor requires to discountfuture incom e to its present w orth. It is m ade up of an interest rate and an equity yield rate. T heoretical factorsconsidered in setting a discount rate are the safe rate earned from a com pletely riskless investm ent (this rate m ayre flect an ticipated loss of pu rch asing p ow er due to in:fIatio n) a nd com pe nsa tion fur risk, lack of liquidity , andinvestm ent m anagem ent expenses. T he discount rate is m ost often estim ated by band-of. investm ent analysis or as ale s c om pa riso n a na ly sis th at e stim a te s ty pic al in te rn al ra te s o f re tu rn ."(3) T he discount rate is a key variable in discounted cash flow analysis, m aking correct rate selection crucial T hem arket's expectations are critical w hen choosing a discount rate. A ccording to th e A ppraisal of R eal Estate bythe A ppraisal Institute (1992): 'T he selection of the yield discount rate is critical to D CF analysis. T o select anapprop riate rate an a ppraiser nru st v erify and in te rpret the attitu des and expe ctation s o f m arket p articip ants,in clu ding buy ers, se llers, a dvisers, a nd bro kers. A ltho ugh the actual yield on an inve stm ent c anno t be ca lc ula te duntil th e investm ent is sold, an investor m ay set a target y ield fur the investm ent before or during ow nersh ip .H istorical y ield rates derived from com parable sales m ay be relevant, but they reflect past, no t future, benefits inthe m ind of the investor and m ay not be reliable indicators of current yield . T herefore, th e s ele ctio n o f y ie ld ra te sfur discounting cash flow s should focus on the prospective or forecast y ield rates anticipated by typical buyersa nd s elle rs o f c om pa ra ble in ve stm en ts. An a pp ra ise r c an v erify in ve sto r a ss um ptio ns d ire ctly b y in te rv iewin g th epa rtie s to com pa rab le sa le s tra nsa ctio ns or ind irectly b y estim ating the inco me ex pec tan cy and likely reve rsionfur a com parable property and deriving a prospective yield rate ."(e) D isco unted cash flow app raisal(1 ) The D CF m ethod is versatile and w idely used to appraise incom e producing property. An a pp ra is er u sin gD CF first projects an anticipated net incom e fur each year of the property 's rem aining econom ic life. E ac h a no ua lcash flow is discounted to present value, and then all the present values are added to obtain th e to ta l m a rk etvalue of the re al pro perty intere st being ap pra ised.(2) The D CF equation is expressed as fo llow s,Figure: 34 TA C 9.403l(e)(2) (N o change.)(3) To estimate the present value (PV ), an estimate of the incom e (cash flow ) to be received in each period isnecessary. The m unber of periods, n (usually years), used in the analysis is determ ined by the m unber of yearsthat the m ineral property is expected to produce a positive net incom e.


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(4) T here are m any variations on the D CF fom ru1a. The fom ru1as vary based on the time th e mo ne y is re ce iv ed ,ie., con tin uo usly, b eg in nin g o f p eriod , m id dle o f p eriod or en d of perio d. T he p eriod m ay be co ntinu ou s, d aily,m on th ly, q ua rte rly , b ian nu al, o r an nu al M an y o il p ro perties are ev alu ated u sin g a n an nu al m id -p erio d d isco un tin gvariatio n o f th e D CF fo mru1 a. T he ap propriate presen t-w orth facto r for m id -year D CF an alysis is:Figu re: 34 T AC 9.4 03 1(e)(4 ) (N o chang e.)( 5) Subsec ti on C D of this se ctio n ( A pp en dix 1 } _illu stra tes h ow a d isc ou nte d cash flo w is ca lcu lated , u sin g am id ye ar fa cto r, fo r a m in era l p ro pe rty .( f) D is count r ate c ompone nts .(1) C om ponents. T he disco un t rate u sed in disco un ted cash flo w an alysis h as several co mpo nen ts. T hese includ e:(A ) i nf la ti on r at e;(B) r is k- fr ee componen t;(C ) g en era l risk p re miu m; an d(D) p rop er ty -s pe cif ic r is k p rem ium(2) T he inflation rate. T he an nu al rate o f price chang e fo r a b asket o f co nsu mer g oo ds. In flatio n is no rm allym easured by the C onsum er Price Index for A ll U rban C onsum ers (C PI-U ), calcu lated by the U nited S tatesB ure au o f L ab or S ta tistic s. T he in flatio n rate is th e m ost b asic com po nent o f a disco un t rate . An in ve sto r's ra te o fre tu rn rrru st eq ua l th e rate o f in flatio n j ust to b rea k e ven in real d olla r tern s.(3) T he risk-free co mp on en t. A retu rn to com pensate the inv estor fo r a loss of liq uid ity . This com po nent can alsob e d efined as th e risk-free rate m in us the in flatio n rate . T he risk-free rate is m ad e up o f th e in fla tio n rate p lu s areturn to reim burse the in vesto r fo r a loss of liqu id ity and is m easu red b y the yield to m atu rity on :federalg ov ern men t sec uritie s w ith a m atu rity p erio d co m pa rab le to th e in ve stm e nt u nd er c on sid era tio n (o il o r g asre se rv es in this c ase ). T he m ark et p erceiv es th ese sec uritie s a s risk-fre e fo r a ll p ractica l p urp oses sin ce th ey areissu ed b y th e U nite d S tates g ov erm ne nt.(4 ) G en era l ris k p rem ium(A ) A return to co mpensate th e in vesto r fo r assu min g d iv ersified co m pa ny-w id e risk. T he w eig hted av era ge co sto f c ap it al (WACC ) minus the risk-free rate is the general risk p rem iu m, T he W A CC is m easured b y w eig htingth e typ ic al o il co mp an y d eb t and equ ity costs b y the typ ical o il com pany d eb t and equi ty c api ta l s tr uct ur epercentages, and then adding the w eighted costs. If one w ere appraising com panies, the W A CC w ould be thed is co un t ra te , sin ce it re fle cts th e m ark et's ex pec te d yield s fro m th e sto ck and d ebt o f a com pany. C alculation ofa W A CC will b e exp lained in m ore d etail later in this manua l(B) Fo r p rop er ty tax p urp oses, ap praisers estim ate th e v alu e o f in div id ual m in eral reserv es, n ot th e v alu e o f o ilc omp an ie s. B u ye rs o f m in era l r ese rv es u su ally p er ce iv e th es e in div id ua l re se rv es a s ris kie r than th e s to ck anddebt of an en tire com pany. C om panies can sp read th eir risk o ver m an y ind iv idu al m ineral reserves an d oftenov er sev eral kind s of assets (som e of w hich are u nrelated to th e o il o r gas b usiness). This as se t d ivers if ica tionreduces the com pany's risk and, as a resuh, the W A CC derived from com pany financial data is usually low er


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than an in div id ual p rod ucin g p ro perty 's d iscou nt rate. H ow ev er, the W A CC is alw ays high er than t he r isk -f reerate. This in cre ase in th e rate is a g en eral risk p rem iu m to rew ard in ve sto rs fo r assu min g th e d iv ersified co m pa ny -w id e ris k.(5 ) P ro pe rty -sp ec ific risk p rem iu m. A re tu rn th at c om pe nsate s th e in vesto r fu r assu min g th e u niq ue risk sasso ciated w ith a p articu Ja r m in era l p ro du cin g p ro perty. T he d isc ou nt rate m in us th e W A C C is th e p ro perty-specific risk prem ium . Investors dem and a prem ium above the W A CC to com pensate them fur this individualp ro pe rty ris k. F or c erta in h ig h- r is k p ro pe rtie s, this prem ium can be quite high. S ee s ub se ctio n (Q l_ [wt3:)-] ofthis se ctio n (A pp en dix 4 ) fu r a list o f p ro perty-sp ecific risk facto rs,(6) C om ponent sum mary. T hese discount rate com ponents can be sum marized: IN FLA TIO N R AT E + RISKFR EE C OM PO NE NT + G EN ERA L RISK PR EM IUM + PROPERTY SPEC IFIC RISK PREM IUM =DISCOUNT RATE.(A ) There are other ways to ' 'build u p" a d isco un t rate. This m eth od 's ad va nta ge is th at th e first th ree co mp on en tsa re q ua ntifia ble fr om p ub lic d ata . The p ro pe rty -sp ec ific risk p rem iu m m ay b e d eriv ed fro m a va ila ble d ata inso me c ases, b ut in g en eral, th e ap pra ise r n ru st e stim ate it.(B) Re fe r t o s ub se cti on (Q l_ [ wt3:)-] of this sec tio n (A pp en dix 4 ) fu r m in eral-p ro pe rty co nd itio ns th at sh ou ld b ec on sid ere d w h en e stim a tin g th e p ro pe rty -sp ec ific risk p rem ium ,(g ) U sin g th e th re e te ch niq ue s.(1 ) C om p on en ts c on tain ed in th e th re e tech niq ues.(A ) M a rke t su rv eys and sa le s a nalysis resu lt in rate s th at in c1 ud e a ll o f th e d isc ou nt rate c om p on en ts. H ow ev er,in th ese tw o tec hn iq ues, th e rate in c1 ud ed fo r th e p ro perty-sp ecific risk p rem iu m is th e ty pical ra te fo r th ep ro perties in c1 ud ed in th e su rv ey o r sa les an aly sis. T he a pp raiser n ru st estim ate th e p ro perty-sp ecific riskp rem iu m (un less th e sales sam ple is d irect1 y c om parable to th e prop erty b eing ap praised ) and ad ju st fu ra ty pi ca 11yh ig h o r low r is k. This m ean s that th e ap praiser nrust red uce th e risk prem ium fo r pro perties w ith lessthan the typical risk an d increase the risk p rem iu m fur p rop erties w ith m ore than t he ty pi ca l r is k.(B) The t hir d te chn iq u e (WA CC ) produces a rate that does not contain a com ponent for property-specific risk .Because it lacks this com po nent, th e typ ical W A CC of po tential p urch asers sets a minirrnnn v alu e fu r a d isc ou ntrate an d th e appraiser n ru st calcu late the typ ical W A CC of po ten tia l p urchasers to kn ow this lower limit. On acase- b y-c ase b asis, th e ap praiser sh ou ld ex c1 ud e o il c om p an ies fro m th e W A C C calcu latio n ifth ey c annotp articipate in th e m arket fur th e pro perty h e o r she is cu rrently app raisin g. F or in stance, sm all co mp an ies m ay n otbe able to bid on certain very valuable oil and gas p ro perties becau se o f in su fficient capital A typ ical W A CC fu rla rg er o il c omp an ie s w o uld e sta blis h a n a pp ro pria te minirrnnn d isc ou nt ra te fu r a pp ra is in g th ese p ro pe rtie s.(C ) An investor should not buy a property at a low er discount rate than h is or her W AC C, otherw ise thein v es to r's n et wo rth will d ecrease. T he ap pra iser n ru st a dd th e p ro pe rty -sp ec ific risk p rem iu m to th e typ ica lW A CC o f p oten tia l p urchasers to d evelo p a disco un t rate . S ee sub sectio n (Q l_[wt3:)-] of this section(A pp en dix 4 ) fu r a list o f p ro perty-sp ecific risk factors,(2 ) D ev elo pin g a ran ge .(A ) Id ea llv . th e an nraiser sh ou ld u se th ese th ree te ch nia ue s sirn ulta ne ou slv to d ev elo n a ra nee o f d isco un t ra tes.


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T he typical W A CC sets th e low er l imit, w h ile su rv ey s a nd d ire ct sa le s a na ly sis p ro vid e a se t o f d isc ou nt ra te sthat th e ap praise r can use as a datab ase that will h elp to estim ate a m id ra ng e d isco un t rate an d an u pp er limit toth e d isc ou nt ra te . E xa m ple s o f th ese te clm iq ue s c an b e fu un d in su bse ctio ns ( 1 ) - (P ) [ S tlB see tiea (k)(3 ) ] o f thiss ec ti on ( th e a ppe ndi ce s) .(B) Som e m ineral prop erties m ay app ear to sell a t or b elo w th e p urchaser's W A CC . T here are several reasonsthat a m ineral p ro perty m ay ap pear to chan ge han ds a t a disco unt rate equal to or less than the W A CC . W hen ab uyer (o r ap praiser) red uces th e cash flo ws to acco un t fo r reserv e reco very risk th e d isc ou nt rate will no t r ef le ctth e risk , b ut th e p urch ase p ric e will. T o calcu late a d isco un t ra te th at is co m parab le to d isco un t rate s fro m o th ersa le s, th e a pp ra ise r m u st q ua ntity th e risk a dju stm e nt a nd a dd it back to th e c as h f low s. This d is coun t r at e will beh ig h er t ha n th e non -r is k- in c lu si ve r at e.(C ) A typ ic al in co m e ta x d ed uctio ns, o r ab no rm ally h ig h o r lo w o verh ead can also create a n artific ia lly h ig h o rlo w d isc ou nt rate . W h en faced with m arket e vid en ce th at w ou ld in dicate a d isco un t rate at less than a c ompany 'sco st o f cap ita l, th e ap praiser sh ou ld rev iew all o th er ap praisal p aram eters to d eterm in e w hy a n ab no rm ally lo wd is coun t r at e i s i nd ic at ed . An u nderstated inco me stream is th e m ost obv io us reaso n T he appraiser m ay be ableto ad ju st th e cash flo ws an d d eriv e a m arket d isco un t rate o r m ay d elete th e sale fro m co nsid eratio n(h ) M a rk et su rv ey s.(1) An ap pra iser m ay u se m arket su rv eys as an in dicato r o f th e d isco un t rate . M an y stu dies a nd su rv eys arep ub lish ed to h elp th e ap praise r estim ate an ap pro priate d isc ou nt rate o r ran ge o f rates fu r ap praisin g o il an d g asp ro pe rtie s. T he S oc ie ty o f'P etro le um E va lu atio n E ng in ee rs ' (S PE E ) A rm u al S urv ey a nd th e W e ste m S ta te sP etro leu m A sso ciatio n's (W S P A ) A nalysis o f O il an d G as P ro perty T ran sfers an d S ales an d D eriv atio n o f aB an d o fIn vestm en t are g oo d ex am ples.(2 ) T he S PE E su rv ey ask s p ro du cers ', co nsu ltan ts ', an d b an ke rs ' o pin io ns o n fu tu re p rices, co st escalatio n a nde conom ic i nd ic e s ( in c lu d in g th e d isc ou nt ra te ) u se d in p etro le um p ro pe rty e va lu atio n(3 ) T he W SPA stu dy, cond ucted by R ich ard J. M iller and A ssociates, consists of tw o parts: an ana lysis of o ilan d g as p ro perty tran sactio ns an d sale s o ccu rrin g in C alifu rn ia fro m 1 98 4 th ro ug h th e cu rren t y ear an d anan alysis o f th e w eig hted a verag e co st o f ca pita l (W A C C) o r ''B an d o f In vestm en t" o f a rep resen tativ e g ro up o fcom pan ies fur th e sam e years. T he W A CC ana lysis is b ased on pu blic data .(i) D ev elo pin g a d isc ou nt ra te fro m sa le s.(1 ) B asic step s. T o d ev elo p a d isco un t rate fro m sales req uire s th ree b asic step s:(A ) o btain recen t sa les p rices fro m a v ariety o f o il an d g as p ro du cin g p ro perties;(B) d ev elo p c ash flo w p ro jectio ns fo r ea ch p ro perty ; an d(C ) calcu late th e in tern al rate o f retu rn (IR R ) fu r each sale . This is also k no wn as th e d isco un ted cash flo w re tu rno n in v es tm e nt (D C FR O I ).(2 ) Sa les sou rces. Infurm ation abo ut sales can b e obtained from a variety o f sou rces, but th e b est source is theb uyer o r seller. O th er so urces th at list sales o f o il an d g as p ro perty in clu de th e T ex as R ailro ad C on nn issio n, O ilan d G as Jo urn al 3 00 , S trev ig an d A sso cia tes, p riv ate firms a nd o il a nd g as co mp an ies. It is im p o rta nt to


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rem em ber that the sale of an oil or gas property nrust be a m arket transaction w hen developing a discount ratef rom s ale s.(3 ) C ash flo w p ro jectio ns. A fter o btain in g v erified sale s p rice s, th e ap praiser d ev elo ps c ash flo w p ro jec tio ns fu reach pro perty . T o th e ex tent p ossib le , the ap praiser n rust talk w ith the parties to each sale to determ ine th eire xp ec ta tio ns o f th e p ro pe rty and tak e th ose in to ac co un t w hen m ak in g p ro jec tio ns. T he v alid ity o f th e d eriv eddisco un t rate is a d irect fim ction of th e am oun t ofinfurm ation ob tained fro m the bu yer an d seller abo ut th eir cashflow p ro je ctio ns. T he a pp ra is er n ru st in co rp ora te this in fo rm a tio n in to h is o r h er p ro je ctio ns . If th e a pp ra is er'sp ro jectio ns d iffe r fro m th e b uy er's an d seller's ex pe cta tio ns, th e d isc ou nt rate d eriv ed fro m th e sa le will beinvalid.(4 ) C alc u1 atin g th e IR R(A ) T he third step in dev eloping a disco unt rate fro m sales is to calcu 1ate th e internal rate o f return (IRR) fu r e ac hs ale . T he IRR is th e yield (d iscou nt) rate at w hich the p resen t value of a cash in co me stream equ als the p resen tvalu e o f the cash ex penditu res (th e sales p rice in o ur analysis) n ecessary to prod uce th at incom e stream . Thisd is count r ate is p ro sp ec ti ve ; it does not depend on the historical perfurm ance of the property, but on the m arketp articip an ts ' e xp ec tatio ns o ffu tu re p erfu rm an ce. T he d isco un t ra te at w hich th e p resen t v alu e o f th e ca sh flo wseq uals the sales p rice can be d eterm ined by tria l an d error. H ow ev er, there are several calcu1 ato rs and perso nalco mp uter so ftw are p ackag es th at can so lv e fu r the disco un t rate (IR R).(B) A hh ou gh c om pu ta tio nal p ro ced ure s m ay v ary slig htly , this m easu re is a lso refe rre d to a s th e p ro fitab ility-ind ex and inv estor's m etho d. T he IR R reco gn izes th at fim ds received n ow are m ore valuable than t ho s e r ec e ivedat so me fu ture t ime. T he investm ent outlay can be regarded as borrow ed fim ds and the pre-tax cash flow as thep aym en t o f p rin cip le p lu s co mp ou nd in te rest o n th e in vestm en t.G) W e ig hte d av era ge co st o f c ap ita l(1) D efin itio n A w idely used m ethod fur deriv in g a pre- tax base d iscou nt rate fur v alu ation p urposes is th e ban dof investm ent, or W A CC teclm ique. The basis fur this an aly sis is th e :fin an cial da ta fro m a b ro ad sam ple o f o ilco mp an ies that deriv e a m ajo rity o f their o perating revenu es from oil and g as pro du ction Since petro leu mp ro perty v alu atio n ty pic ally in vo lv es d isco un tin g c ash flo ws o ve r a lo ng p erio d o f t ime, a lo ng -term co st o f cap ita lis m ost app ro priate fur develop in g an oil or g as p rop erty d isco unt rate. T hu s, the app raiser sho uld incorpo rate abroad t ime series of data to app rox im ate a long -term co st of cap ita l(2 ) R eq uired ca lcu 1a tio ns. F ou r sets o fca lcu 1a tio ns are re qu ire d to d eterm in e th e W A C C.(A ) T he ty pic al c ap ita l stru ctu re is d eriv ed and expressed as a proportion of debt and equity .(B) T he typical co st of o utstanding debt is calcu 1ated based o n b on d yield s.(C ) T he typical cost of equity is com puted using the C apital A sset P ricing M odel (C APM ) or another m ethodsuch as the DCF M odel(D) D eb t and equ ity costs are w eig hted acco rding to th e typ ical capital structure p ercen tag es and add ed tod eriv e a typ ica l co st o f cap ita l( 3) C a pita l s tr uc tu re .


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(A ) "C ap ital stru ctu re " d esc rib es in p erce ntag e te rm s th e so urces o ffim ds (ca pital) u sed to p urch ase th e assetsnecessary to o perate a com pan y. The cap ital stru ctu re o f an y com pany con sists o f d eb t and equ ity . T he debtp ortio n co nsists o flo ng - term d eb t (re pre se nte d b y o utsta nd in g b on ds) an d p refe rre d sto ck, w hile th e eq uityportion consists of outstanding conm on stock. If the com pany is fim ded by debt and equity of equal value, thecap ital stru ctu re is 50 % d ebt and 5 0% equity .(B) T o estim ate a d iscou nt rate fur m ass-app raisal pu rpo ses, th e ap praiser sho uld use th e typ ical m arket capitalstru cture fur a rep resentative gro up o f m ajor and ind epend en t o il co mpan ies that deriv e a m ajo rity o f theiro pera tin g re ve nu es fro m o il an d g as p ro du ctio n(4) C ost o f debt. T he yield -to -m aturity is th e best ap proxim atio n of th e cost of debt capital This y ie ld i sobservable in the m arketp lace and can be found by referring to Standard and Poor's C orporation B ond G uide,M oo dy 's B on d R ep ort, o r a com parable p ub lication(5) C ost o f eq uity.(A ) T he C APM is the preferred approxim ation of equity cost since it c on sid er s b oth h isto ric al m a rk et y ie ld s a ndcu rrent exp ectation s, plas a m arket-d erived eq uity risk facto r, T he C AP M m eth od m easu res the co st of equ ityb y con sid ering that an investor's req uired rate o f return on co nm on stock is com prised o f a risk- free retu rn p lusa risk -ad ju stm en t fa cto r re lated to th e sp ecific sto ck. This is rep resen ted by the fo l lowing e qu ati on : K =Rfc +B(Rm- Rfh) w here: K = cost o f eq uity (after tax), % /year; R fc = cu rre nt risk-fre e rate , % /y ea r; R m =historicm ark et retu rn o n eq uities, % /ye ar; R fh = histo ric m arket retu rn on lo ng- t erm g ov ern men t bo nd s, % /year; B =BETA coef fi ci en t.(B) T he cu rre nt risk - free rate (R fc) is ty pic ally b ase d o n c urren t lo ng - term g ov ern men t se cu rities, ie., th e yie ld -to -m atu rity ob served on an ann ual basis on a defau lt- free treasu ry b on d, no te , or b ill o f the relev an t time period.Fo r o il an d gas p rop erty app raisal, the yield o n a lon g-term b on d is an ap pro priate m easu re o f th e risk-free rate .(C ) T he historical m arket retu rn on equ ities (R m ) on con mon stocks an d the histo rical aritlnn etic m ean on lon g-term go vern ment bon d in com e returns (R fh ) can be ob tained fro m Ibb otson A sso ciates' S tock, B ond s, B ills andIn fla tio n T he b eta c oe ffic ie nt (B) m easu re s m arke t risk b y reg re ssin g th e sto ck's to ta l retu rn ag ain st th e m arket'sto tal retu rn A m ore detailed description of th e beta calculatio n can b e found in th e Ib bo tso n A sso ciates re po rt.T he b eta co efficie nt v alu e ca n b e o bta in ed fro m V alu e L in e P ub lish in g, In co rp orate d's T he V alu e L in eIn vestm en t S urv ey , S tan dard an d P oo r's C orp ora tio n's S &P S to ck R ep orts an d sim ilar in ve stm en t se rv ice s.(D) T he d ifference betw een th e h istorical risk-free (R fh ) and m arket (R m ) rates o f retu rn is a m easu re o f then on -syste ma tic o r n on -m ark et rela ted risk c au sed b y ch an ge s sp ec ific to th e co mp an ies co m prisin g th e sto ckrate of return sam ple and is, in effect, an eq uity risk p rem iu m. N ote that tw o differen t risk-free rates o f retu rn areu sed in the C AP M. T he cu rrent risk-free rate (R fc) is u sed to ackn ow ledg e the ex pectatio nal fim ctio n o f them od el T he h isto rica l risk-free ra te (Rfh) is u se d in c on ju n cti on with th e h isto rica l m arke t retu rn fu r th e sam e timep erio d w h en c alc ula tin g th e e qu ity risk p rem ium .(E ) T he co st o f eq uity resuh ing from this m od el is a no minal (curren t dollar) after tax rate. C onv ersio n to an om in al, p re -ta x ra te re qu ire s d iv id in g th e e qu ity c os t (K) by one minus th e fed era l sta tu to ry in co me ta x rate fu rp etroleum co mp an ies. T he incom e tax rate is presently 35% . This is re pre se nte d b y th e fu llow in g e qu atio n:K(pre-tax) = K /(l - .3 5). If th e ap pra iser ca lcu lates a ty pical effectiv e in co me ta x rate fro m a re pre sen ta tiv esam ple o f petro leu m com panies th at cou ld p articipate in th e m arket fur th e pro perty that h e o r sh e is app raisin g,


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th e a pp ra is er m a y su bstitu te th at ty pic al e ff ec tiv e in come tax ra te fu r th e statu to ry rate .(6) W e ig htin g d eb t an d e qu ity c osts.(A ) O nce capital structure, d eb t, an d equ ity costs are determ ined , the :finalstep in d erivin g th e W A CC is tow eig ht th e co st of deb t and eq uity b y th e p ro po rtio na l sh are ea ch h as in th e o vera ll ca pital stru ctu re. This isre pre se nte d b y th e f ullow in g e qu atio ns.Figu re: 34 T AC 9.4 03 1G )(6)(A ) (N o ch an ge.)(B) T he W A CC estim ating technique is illustrated in subsection .{m )_[ ~] of this se ctio n (A pp en dix 2 ).(7 ) F in al d isc ou nt ra te s ele ctio n(A ) A s d iscu ssed earlier, th e typ ical W A CC of po ten tia l p urchasers sets th e low er en d o f the disco un t raterang e. T o help estab lish the u pp er end of the disco un t rate ran ge, th e ap praiser can calcu late a stan dard dev iatio nof all th e d iscou nt rates in dicated by the sales in the sales sam ple and th e su rv ey. O ne sta nd ard d ev ia tio n ab ov ean d below th e m ean con tains 68 % of all th e o bserv ation s in a n orm ally d istrib uted set of data. T wo stan darddeviatio ns ab ov e an d b elo w the m ean con tains ov er 99 % of all th e o bserv ations in a no rm ally d istrib uted set ofdata. T he data m ay no t be norm ally distribu ted . E ven so , this k in d o f an aly sis m ay h elp th e ap pra iser to estab lishth e up per en d of the d iscou nt rate ran ge.(B) V ery h ig h-risk p ro perties (fur ex am ple, a on e-w ell lease w ith high w ater produ ction n ear th e end o fitseconomic l i fe) m ay be discounted by the m arket at tw o standard deviations above the m ean Properties w ithl es se r r is k will h av e co rre sp on din gly lo wer d isco un t rate s. O ne stan dard d ev iatio n a bo ve th e m ean m ay estab lisha n u pp er l imit fu r prop erties in a typ ical risk-rang e. T he m ean or m ed ian o f th e disco un t rates fro m the salesan aly sis an d th e su rv ey in dic ate s th e m id -ran ge d isco un t ra te .(C ) F or a stan dard d eviation analysis to hav e m eanin g in selectin g an u pp er l imit to th e d iscou nt rate rang e, th esu rv ey or sales d ata set rrru st c on tain p ro perties w ith b ro ad ly varying risk. A hig h-end disco un t rate selected bythis method will n ot ap ply to v ery risky p ro perties (it will b e to o lo w) unless these risky prop erties arerepresented in the sales data set u sed in th e analysis.(D) T o sele ct a d isc ou nt rate fu r an in div id ua l p ro pe rty , th e ap pra ise r rrru st a sse ss th e p ro perty -sp ecific riskinherent in the property. Subsection(Q l_[~] of this sec tio n (A pp en dix 4 ) lists risk fac to rs th at sh ou ld b eta ke n in to a cc ou nt.(k) Sumnary,(1 ) This m an ual describes m etho ds and pro cedu res u sed to calculate the present v alu e o f o il an d gas p rop ertiesu sin g disco un ted fin ure in com e. T he d iscou nted cash flow m etho d, D CF, is th e m ost w idely u sed m eth od toappr ai se miner al p rope rt ie s.(2 ) W ith in th e D C F e qu atio n, th ere are th re e g en era lly a cce pted tech niq ues fu r e stim atin g a d isco un t ra te: m arketsu rv ey s, o il an d g as sa les an aly sis and th e w eigh ted average co st of cap ita l Ideally, th e app raiser sho uld useth ese th re e tec hn iq ues sirrru han eo usly to d ev elo p a ran ge o f d isc ou nt rate s.(3) T he evaluatio n of o il an d gas p rop erties d em on strates the im portan ce o f v iew in g a disco un t rate in th e co ntex t


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o f th e e ntire a pp ra isa l, in clu din g th e p ro du ctio n d ec lin e ra te , p ric e, a nd c ost p ara m ete rs. T he d isc ou nt ra te sh ou ldn ot b e co nsid ered an iso la ted v ariab le , fo r it is o nly o ne co mp on en t o fa co mp lex in teractio n o f v ariab les th atc olle ctiv ely d ete rm in e a n e stim a te o f v alu e.[Figttfe: 34 TAC 9.4031(k)(3)](1 )A p pe nd ix 1 .F ig ure : 3 4 T AC 9.4 03 1(1 ) (.p dfl(m ) A ppend ix 2 .F igu re : 34 T AC 9 .4 031(m ) (.pd fl(n ) A pp endix 3 .F i& ure: 3 4 T AC 9.4 03 1(n ) (.p dfl(0 ) A ppend ix 4 .F i& u re : 34 T A C 9.4 03 1(0 )(p ) A ppend ix 5 .F i& ure: 3 4 T AC 9.4 03 1(p ) (.p dflThis ag en cy h ereb y certifies th at th e p ro po sa l h as b een re view ed b y leg al co un sel an d fo un d to b e within th ea ge nc y's le ga l a uth or ity to a do p t.Filed with th e O ffic e o f th e S ecretary o f S tate o n A ug ust 2 9,2 01 1.TRD-201l03492A s h le y Ha rd e nGener al C oun se lC omp tr olle r o f P ub lic A c co u ntsE arlie st p ossib le d ate o f a do ptio n: O cto be r 9 ,2 01 1F o r f urth er in fo rm a tio n, p le as e c all: ( 51 2) 4 7 5- 03 8 7

Proposed Rule on § 9.4031, 34 Tex. Reg. 5753-6066 (Sept. 9, 2011)

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Transcript of Proposed Rule on § 9.4031, 34 Tex. Reg. 5753-6066 (Sept. 9, 2011)