Why Invest in Oil & Gas?
Invest in oil and gas for:
- Income - partially sheltered
- Tax Advantages - 70-85% tax deduction on investment and reducing AMT
Oil and Gas Spot Prices
Oil & Gas Demand: From global population growth, developing
nations, dependence on foreign oil, "Demand growth is highest in the developing world.
World demand for oil is projected to increase 37% over 2006 levels by 2030, according
to the US-based
Energy Information Administration's (EIA) annual report"—Wikipedia.org
"--global oil consumption will jump by some
35 percent by the year 2030, according to the International Energy Agency, a leading
global energy forecaster for the United States and other developed nations. For
producers it will mean somehow finding and pumping an additional 11 billion barrels
of oil every year."
--Jad Mouawad, New York Times
As staggering as it may seem the entire world’s
use of oil has been calculated at around 85 million barrels per day.
Developing nations such as China, India and others who rely heavily on oil imports
for their booming and growing economies have put huge pressures on the world consumption
rate. These developing nations need for oil only increase with time and with
the world’s population expected to double from 2.2 billion to 5 billion people the
appetite for oil without question will increase.
"The United States devours more than 20 million
barrels per day, with almost half of that made into gasoline. American drivers burn
about 141 billion gallons of gas every year. In California, it's close to 16 billion
gallons per year."
--David R. Baker, San Francisco Chronicle Staff Writer
Tax Advantages of Oil and Gas Drilling
From Houston Chronicle, October 12, 2004
Congressional Incentives Encourage Domestic Petroleum Development
Oil and natural gas from domestic reserves helps
to make our country more energy self-sufficient by reducing our dependence on foreign
imports. In light of this, Congress has provided tax incentives to stimulate domestic
natural gas and oil production financed by private sources. Drilling projects offer
many tax advantages and these benefits greatly enhance the economics. These incentives
are not “Loop Holes” -- they were placed in the Tax Code by Congress to make participation
in oil and gas ventures one of the best tax advantaged investments.
Intangible Drilling Cost Tax Deduction
The intangible expenditures of drilling (labor,
chemicals, mud, grease, etc.) are usually about 70% to 80% of the cost of a well.
These expenditures are considered “Intangible Drilling Cost (IDC)”, which is 70%
to 100% deductible during the first year. These deductions are available in the
year the money was invested, even if the well does not start drilling until March
31 of the year following the contribution of capital (See Section 263 of the Tax
Code).
Tangible Drilling Cost Tax Deduction
The total amount of the investment allocated to
the equipment “Tangible Drilling Costs (TDC)” is 100% tax deductible. In the example
above, the remaining tangible costs ($25,000) may be deducted as depreciation over
a seven-year period (See Section 263 of the Tax Code).
Active vs. Passive Income
The Tax Reform Act of 1986 introduced into the
Tax Code the concepts of “Passive” income and “Active” income. The Act prohibits
the offsetting of losses from Passive activities against income from Active businesses.
The Tax Code specifically states that a Working Interest in an oil and gas well
is not a “Passive” Activity, therefore, deductions can be offset against income
from active stock trades, business income, salaries, etc. (See Section 469(c)(3)
of the Tax Code).
Small Producers Tax Exemption
The 1990 Tax Act provided some special tax advantages
for small companies and individuals. This tax incentive, known as the “Percentage
Depletion Allowance”, is specifically intended to encourage participation in oil
and gas drilling. This tax benefit is not available to large oil companies, retail
petroleum marketers, or refiners that process more than 50,000 barrels per day.
It is also not available for entities owning more than 1,000 barrels of oil (or
6,000,000 cubic feet of gas) average daily production. The “Small Producers Exemption”
allows 15% of the Gross Income (not Net Income) from an oil and gas producing property
to be tax-free.
Risks of Oil and Gas Investing
- Prices of oil and gas are highly volatile
- Reserve estimates are not an exact science
- Difficult to leverage
- Alternative energy sources
- Production expenses
Lease Costs
Lease costs (purchase of leases, minerals, etc.),
sales expenses, legal expenses, administrative accounting, and Lease Operating Costs
(LOC) are also 100% tax deductible through cost depletion.
Alternative Minimum Tax
Prior to the 1992 Tax Act, working interest participants
in oil and gas ventures were subject to the normal Alternative Minimum Tax to the
extent that this tax exceeded their regular tax. This Tax Act specifically exempted
Intangible Drilling Cost as a Tax Preference Item. “Alternative Minimum Taxable
Income” generally consists of adjusted gross income, minus allowable Alternative
Minimum Tax itemized deduction, plus the sum of tax preference items and adjustments.
“Tax preference items” are preferences existing in the Code to greatly reduce or
eliminate regular income taxation. Included within this group are deductions for
excess Intangible Drilling and Development Costs and the deduction for depletion
allowable for a taxable year over the adjusted basis in the Drilling Acreage and
the wells thereon.