Return Potentials of oil and gas investments

Each project has an individual risk/reward profile. There is less risk in developmental wells than exploratory wells and there is a tradeoff for the reduction in risk. Although developmental projects can provide steady production and cash flow, they rarely generate the kinds of returns available in successful exploratory wells. When evaluating a prospect, it is important to first decide what degree of risk you are comfortable with. There can be no assurance that any venture will be successful. However, if you think participation in an oil or gas venture might be for you, evaluate each prospect on a cash-on-cash basis before considering the tax benefits.

Tax Advantages of Oil & Gas Investments

In order to encourage domestic oil and gas drilling, Congress has made participation in oil and gas ventures one of the top tax advantaged investments available. Many individuals find these write-offs to be a very valuable part of their year-end tax strategy. If you'd like to learn more, see our section below on tax considerations.

Potential Risks of Oil & Gas Investments

As with all investments, there are significant risks associated with investing in oil and gas joint ventures. The most significant risk of participation is that drilling could result in a dry hole, thus resulting in a loss of all capital contributed to the project. A dry hole is an exploratory or developmental well which is found to be incapable of commercially producing oil and/or gas in sufficient quantities to justify completion. Although our technology has improved significantly in the past few decades, success rates will still vary for each project. It is impossible to accurately predict the outcome of any project. Due to the structure of joint ventures, the capital contributed on a dry hole would be lost. This is the main reason many experts advocate managing risk through diversification.

Investor Suitability Standards

Investing in energy projects can be exciting and rewarding. However, because of the significant risks involved, investors must have a certain degree of investment acumen, business knowledge and financial stability. Many companies prefer that an investor be accredited. However, some non-accredited individuals that have significant industry and investment experience may also qualify to participate in a joint venture.

Selecting the Right Oil & Gas Company

When considering an oil and gas investment, it's important to do your due diligence. The most important aspect of an oil and gas investment is who you're working with. Here are some tips to help you find out if you're working with a reputable company. Make sure you're investing with a registered broker-dealer and member of the Financial Industry Regulatory Authority. Registered broker-dealers are held to the highest standards of disclosure and are subject to audit by state and federal regulatory authorities, including the U.S. Securities and Exchange Commission (SEC), State Securities Board and FINRA.
How long has the company been in business?
What is their track record, including the amount of money invested and the net amount of cash received by investors per project? Many companies will show the number of wells completed, but it's important to know that many "completed" wells never pay out because they are dry holes or they fail to provide commercial reserves. A long list of "completed" wells tells you nothing about the company's success rate. How does the company select its projects? Who does the company rely on for geological/geophysical analysis? Does the company have an on-staff geologist? Are they the operaters of the wells and what kind of experience do they have?
Ask to speak to existing investors to find out what their experience has been with the company. Does the company provide information to keep investors informed on every stage of the drilling and completion of a project in a timely manner? Do they provide disbursements and Schedule K-1 forms in a timely manner? Do they provide the AFE (approved financial expenditure)? Do they supply an audited company balance sheet and business referrals?

Why Invest?

As oil and gas supplies are declining, the global demand is on the rise. Over the last five years, the world burned 30 billion barrels of oil each year, however it only discovered 3 billion barrels of new oil each year. Oil is used to manufacture virtually everything we use on a daily basis, from clothing and pharmaceuticals to detergents and insulation. The facts are there are thousands and thousands of petroleum-based products that we rely on everyday. This translates into opportunity for smart investors. Crude oil and natural gas are finite resources and we are currently using more oil worldwide than we are producing. Economics 101 tells us that when a commodity supply decreases and demand on that same commodity increases it can mean only one thing - Higher prices! Now you can take advantage of the higher prices to come with a direct investment in oil & gas. In fact, with the instability associated with many oil producing countries, many experts believe that oil prices could get as high as $200 to $300 a barrel soon.

According to the U.S. Department of Energy; " Oil supply disruptions over the past three decades have cost the U.S. economy about $4 trillion, so supply shortfalls associated with the approach of peaking could cost the U.S. as much as all of the oil supply disruptions since the early 1970's combined".

Tax Considerations

Overview

Through direct participation programs in oil and gas, investors actually own a portion of the well and receive a share of the cash flow generated via monthly or quarterly disbursements. In addition to the income potential, oil and gas investments offer substantial tax benefits, which the U.S. government has designed to encourage domestic drilling. Since the Tax Reform Act of 1986, direct participation programs in oil and gas are one of the few remaining investments that allow investors to shelter income, making it one of the most tax advantaged investments today. Investors may be able to deduct as much as 70 percent or more of their investment within the first year, whether the wells are successful or not, and 15 percent of the income generated from your investment is generally tax free via IRS allowed depletion allowances.

Oil and Gas Investing Tax Treatment

The Tax Reform Act of 1986, made significant changes to the tax laws as they pertain to oil and gas investments. It attempted, for the most part, to shift more of the tax burden from individuals to corporations and affected the ability of taxpayers to shelter income. It also allows Domestic Intangible Development costs to be expensed or capitalized at the discretion of the taxpayer. Furthermore, intangible costs may be deducted by the taxpayer in the year the well is drilled.

Tangible Developmental Costs

Currently, the drilling of a oil and/or gas well is considered production of an asset. The tangible well costs are capitalized and amortized over a seven (7) year period, beginning with the month in which they are paid.

Depletion

Independent producers and royalty owners can claim percentage depletion of 15% on domestic production. Depletion costs may be recovered using whichever of two (2) methods provides a higher deduction, cost depletion or percentage depletion.

Percentage depletion for oil and gas properties is limited to independent producers and royalty owners for daily production up to 1,000 barrels of crude oil or an equivalent amount of natural gas. However, percentage depletion cannot exceed 65% of overall income.

Investing in Oil and Gas Can Be Rewarding

Although there is principal risk associated with investing in oil and gas programs, there are substantial benefits. In addition to the aforementioned tax benefits, informed and selective investors have the potential to recover their initial investment and continue to receive cash distributions for many years.

The Independant Producer

America's determination to increase domestic researves and be free of OPEC dependency has placed a tremendous need for capital on oil and gas companies. The burden is particularly heavy for independent producers whose funds are more limited than those of major oil and gas companies which fund their drilling activities with the sale of stock. Most Independant Operators, which drill the majority of the Nation's wells, are able to provide investors with cash flow and tax advantages through direct participation in oil and gas programs, thus avoiding the major oil companies' corporate overhead.