Investments + Services
Natural Gas and Oil Drilling Programs
Investment in an oil and natural gas drilling operation is an investment in the exploration, drilling and operation of well production and the sale of that production.
Benefits of drilling programs include immediate and future income tax savings, potential monthly cash flow commencing 9-12 months post investment, and a possible cash flow life of up to 20 or more years.
Drilling operators will generally have an in-house or closely affiliated team of experienced geologists, petroleum engineers, production, pipeline, and administrative professionals that are responsible for all aspects of managing the program, including:
Common Drilling Program Structures
The oil and gas drilling programs we broker are structured as limited partnerships that provide an investor with the option to invest in general partner units that subsequently convert to limited partnership units, or to invest directly into limited partner units. The form of an investor’s initial investment will determine which significant tax benefits an investor in domestic oil and gas drilling receives. Investors should consult their tax advisor for any tax advantages or disadvantages pertaining to their current situation.
Investing in general partner units allows an investor to use the tax benefits in the calendar year of their investment to offset any type of income including some alternative minimum taxable income. As a general partner the investor will have unlimited liability regarding partnership activities occurring during the drilling period which is usually within 9 to 12 months after the Partnership is closed to new investment. Once all drilling is complete the general partner units automatically convert to limited partnership units and the investor does not have unlimited liability for partnership activities occurring subsequent to the conversion.
Investing as a limited partner will provide the investor with limited liability from the beginning through the end of the investment, however, use of the tax benefits will be more restricted than those of the general partner investor.
To mitigate against an investor’s general partner liability exposure Alvery Bartlett Group has selected investments from sponsors that provide each partnership with a minimum of $50 million liability insurance and an indemnification of the general partner unit holders against any partnership liability in excess of those general partner units. This indemnification is typically backed by a publicly listed sponsor with significant net worth which in some instances is more than $300 million. Sponsors will also ensure that all outsourced subcontractors working on the well sites provide proof of insurance and that workers compensation is in place to protect workers and limit liability for work related accidents.
Tax Treatment of Drilling Program Investments
Oil and natural gas together supply approximately 60% of the United States’ energy needs. Approximately 85% of our natural gas is supplied by domestic sources, with most of the balance supplied by Canada. Currently over 60% of our petroleum supply is imported, much of it from politically unstable regions of the world. Given these facts it is not surprising that the U.S. government encourages the development of domestic oil and natural gas through its tax policy.
Investors who participate in a typical drilling program as a general partner can generally deduct in the current tax year approximately 88% to 90% of their investment from any form of income. General partners can use this deduction to reduce payroll withholding taxes, quarterly tax payments, and may use the deduction to reduce federal and state income tax, self-employment tax, alternative minimum tax and phase-out of deductions and exemptions. Those who invest as limited partners may use their deduction only against “passive” income such as income from limited partnerships and rental properties.
Once the program begins making monthly income distributions that income receives an ongoing tax shelter of approximately 20%-30% for the life of the partnership due to percentage depletion allowance. Depletion is similar to depreciation except that it is associated with minerals such as oil and natural gas. For large oil and natural gas companies depletion is limited to the cost basis of their properties, but for small producers and individual investors there is a special form of depletion, called percentage depletion, which allows an investor to deduct a percentage of total revenue, (before deducting operating costs) from a property. Percentage depletion is not limited to the cost basis of the investment and may continue to be deducted as long as oil or natural gas is sold from the wells. Therefore the total depletion write offs could ultimately exceed your investment.
If you are considering this type of investment you should consult with your own tax advisor to better understand how these special tax treatments may apply to your tax matters.
Factors Affecting Income Distributions: Monthly net income from drilling programs is based on a number of factors that can generally be condensed into three groups:
Oil and natural gas prices can be volatile as recent events have illustrated. Oil has a multitude of end uses, from gasoline to plastics. Natural gas is used primarily for electrical generation and heating. While oil is shipped easily across oceans, over 95% of the natural gas used in the United States comes from the North American Continent due to shipping difficulty. While the price of natural gas is not as affected by world events as oil, there is a direct relationship between oil and natural gas prices since many large users can switch between the two.
Revenues from production will be reduced by fixed costs that typically include royalties paid to the mineral rights owner, severance taxes on the production, and well tending costs.
Quantities of oil and natural gas are expressed in barrels for oil and cubic feet for gas. Oil wells produce mostly oil with natural gas as a byproduct which can generate some additional income. Natural gas wells generate their income primarily from the flow of natural gas, although most of them also produce condensate (oil which is expelled as a vapor but condenses into a liquid). Condensate can sometimes be a significant source of revenue.
A result of these factors is that investors in oil and natural gas drilling programs are likely to experience monthly income distributions that are variable and affected by seasonal spikes in demand.
Natural Gas and Oil Royalty Interest Investments
Subsurface real estate interests (i.e. where an owner’s interests lie underground) are often referred to as mineral rights and include interests in oil, natural gas, coal, and other minerals. Owners of oil, natural gas, coal, and mineral, royalty and overriding royalty interests are entitled to share revenues from the drilling operator’s production. Revenue sharing agreements generally range from 12.5% for royalty interests and 2% - 5% for an overriding royalty interest. Payments and cash flow are based on the actual production and are not guaranteed.
Royalty program sponsors should have the organization, professionals, and systems in place to properly analyze, operate, and provide investors with all their administrative services and year-end tax reporting needs.
Royalty investment programs are intended to have a long life with proven reserves of 25 or more years. The working interest operator, not the royalty owners, is financially responsible for costs associated with exploration and development. During the life of a lease the royalty owners have no control over future development of their property. It is important for the owners to consider the property development plans so they can determine its future potential and investment value.
Article and white paper discussing oil and natural gas investing:
“Royalties vs. Drilling
in Your Investment Portfolio”
Investments in oil & gas programs are highly speculative and involve risks. You must be prepared to bear the economic risk of an investment for an indefinite period of time and be able to withstand a total loss of your investment. This material does not constitute an offer to buy or sell any security. Such offers can only be made through a private placement memorandum or prospectus which contains a complete discussion of risks involved in the investments. Read the applicable prospectus before you invest or send money.
Oil and Gas Risk Factors:
This material does not constitute an offer to buy or a solicitation of an offer to sell any security. Such offers can be made only by a Private Placement Memorandum to accredited investors. These investments involve a high degree of risk and are not suitable for all investors. Please refer to the Risk Factors section of any specific Private Placement Memorandum.
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