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 OIL and GAS INVESTING FAQs Is Oil and Gas a Profitable
Investment? IS OIL AND GAS A PROFITABLE INVESTMENT? IS OIL AND GAS A SAFE INVESTMENT? Yes, investing in the oil and gas industry can
be a safe investment. As we eluded to earlier, one of the safest
investments is to own stock in what many consider to be "blue
chip" companies known as the "Majors" in oil and gas.
WHAT WAYS ARE THERE TO INVEST? Major Oil Company Stock - All of the major oil companies that own the majority of reserves throughout the world are probably traded companies. As an investor interested in oil and gas, their stock can be considered one of the safest investments in oil and gas. However, as a general rule, they do not provide a high rate of return. Medium-sized Oil and Gas Companies - Many of these are publicly traded on the New York Stock Exchange, as well as the NASDAQ and other exchanges throughout the world. Again, these stocks can offer a higher rate of return, but potentially have more risk due to the fact that most of these companies are still acquiring assets and going through a growth process. Mutual Funds - These focus their portfolios towards the energy industry. They may own stock in the majors, stock in independents or stock in companies that provided a variety of services for the oil and gas industry. There may even be some direct participation in oil and gas development or exploration projects. Independent Oil and Gas Companies - There are over 4,000 independent oil and gas companies located in the United States. Many of these firms offer the opportunity to invest with independent producers in industry development projects as well as exploration. These direct participation investments are called private placement and can utilize the full capability of the tax benefits.
Drilling Funds - In the early 1980s, many of the small independent companies that were publicly held provided funds that specifically targeted drilling projects.
Commodities Trading - Oil and gas are traded on a daily basis in different exchanges throughout the world. Oil is the commodity that is most commonly referred to as West Texas Intermediate. This commodity is traded on a daily basis in contract increments of 5,000 barrels. Even though you are investing in the oil and gas industry, or one of the products of the industry, you would be described as a speculator.
Royalty Funds - Generally speaking, a royalty fund is when royalty interests are being bought, sold and held by the funds sponsors. In nearly all leasing situations, once a lease has been developed, it provides a revenue stream. A portion of the revenue stream is set aside for royalty which generally amounts to 12.5 percent and overriding royalty and/or carried working interest of 2 to 5 percent.
Lease Acquisition Funds - The main feature with this type of fund is that the fund will retain a royalty for accumulating the leases that it will "turn" into an operating company. Generally, the funds are used for acquiring acreage in developing exploration plays. These types of acquisition programs offer a higher degree of risk, but can generate a significant return on equity if the sponsors of the fund are able to turn their acreage to other exploratory type oil companies. Combination Funds - These are what they sound like, a combination of acquisition and drilling funds. Generally, this type of fund will target a regional-type oil development play whereby they will acquire existing properties and then do a developmental drilling program on the properties they have acquired. These types of programs generally have a high degree of success and offer an excellent rate of return as well as providing a minimal amount of risk. To properly analyze these investment vehicles, it is important to devote the time and energy into understanding the company and its projects. HOW DO I ASSESS A POTENTIAL OIL & GAS INVESTMENT? Understanding or assessing potential really starts with a two phase process:
The Company From the due diligence you should be able to determine how well an investor has fared in prior programs, how economical the programs have been and how sound the proposed undertaking might be. Technical due diligence will help eliminate most of the unsound investment proposals. One area of the due diligence I like to focus on is "Prior Activities." Basically, this will summarize the programs the firm or company has drilled in the past and how they have fared. Prior activities will cover when the offer commenced, the amount of the offering, the minimum size of units, the method of offering (private or public), the number of wells in the project and the type of wells (development, waterflood, exploration). It will also cover the net revenue, the frequency of payments (monthly, quarterly, dry hole) and it should also state the amount of the promoted interest. The projects should then be summarized by lease name and a yearly account of the gross revenue, operating expenses, net revenue and cumulative barrels. You should be able to determine an average return on revenue as well as a total return on investment. I have found that these numbers can and will provide you with a fairly accurate track record of the types of projects that this company has developed. As an investor you should try to determine the credibility of the company under investigation. One of the best ways I've found is to refer to the section of the due diligence covering corporate references. Here you will find a list of references and areas in which they do business. It may be accounting, supply stores, service companies, etc.
The Property Unless you have a proper understanding of geology and/or engineering your best course of action may be to consult with an energy analyst or advisor that is knowledgeable about the company and/or projects you are considering. Quite frankly, the hardest part about determining whether an oil and gas project will be successful is trying to locate the specific benefits of the project through the terminology the geologist or engineer is using for a given area. The best way to evaluate an oil project is to try to determine how successful the other wells that were drilled in the area were. What we are really looking for is a history of wells that have been drilled in a given area and what type of reserves have been recovered. This should serve as a benchmark in determining the probability of success in this project. In most drilling proposals or geological reports, what has been produced in the past will give a summary or probability of what might be expected in the future or throughout the drilling process. Analyzing geological and engineering reports is a process that should be undertaken by someone with the proper investment acumen as well as understanding of geology and engineering. The best description of this individual would probably be an energy analyst. However, with a little common sense and time devoted to research and understanding, a non-industry individual should be able to determine the proper investment scenario. Again, we come back to the question of how we asses the potential of an oil and gas investment. The two phases that I referred to in the preceding section are only a cursory review. There are many aspects of an oil and gas project that need to be addressed. Some of these are sharing arrangements, deal terms, liabilities, market for product, transportation, further development and many other subjects. WHAT ARE THE TAX BENEFITS OF OIL AND GAS INVESTING? Intangible Drilling Cost (deductible in full) In the process of drilling a well, there are certain expenses incurred that have no salvage value. They may be labor, drilling expenses, testing, etc. These expenses generally represent from 40 to 60 percent of the total cost of the well. The investor's proportionate share of these intangible expenses can be deducted as a cost of operation in the year in which they were incurred. Further reference: Sec. 263a of the 1986 Internal Revenue code. Intangible Completion Costs These are treated the same as intangible drilling costs. These are approximately 10 to 15 percent of the cost of the well. Depreciation Equipment used in the completion and production of a well - pumping units, tanks, well casing and any other physical equipment - is depreciated over a seven-year life under the new Modified Accelerated Cost Recovery System (MACRS). Tangible Completion Expenses These usually represent 25 to 40 percent of the total cost of the well. Depletion Allowance Fifteen to 20 percent of the gross annual income from the production of a well is tax free revenue (according to IRS guidelines on producing heavy oil or stripper wells from 1993 forward). Alternative Minimum Tax The percentage of depletion allowance for independent producers or investors is no longer a tax preference item for the Alternative Minimum Tax (effective for tax years beginning after 12/31/92). Percentage depletion has been repealed as a preference item.
HOW CAN I GET MORE INFORMATION ON OIL AND GAS INVESTMENTS? There are a few books that are specific to oil
and gas investments. They are "The Why's and How's of Investing
in Oil and Gas" by Lewis Mosburg, Jr. and "Money in the Ground"
by John Orban. |
