Why Invest in Oil and Natural Gas
Billions of Dollars Invested by Institutional and Professional Investors.
Every year very sophisticated individual and institutional investors from outside the oil business put billions of dollars into drilling for oil and gas in the United States. These oil and gas investors include extremely wealthy individuals, foreign investors, trust departments of major banks, large life insurance companies, major industrial companies, and pension funds who invest in oil and gas drilling strictly for profit as they have no need for the tax benefits.
Why do they invest in oil and gas when they can choose from the whole spectrum of investments and they know firsthand the risks of exploring for oil and gas? They invest in oil and gas to get invulnerable long-term economic value, cash flow, dramatic upside potential and permanent tax benefits.
Long-Term Economic Value.
Even though oil and gas wells deplete over the years, oil and gas properties often become more valuable with age, even after a large portion of their primary reserves has been produced. There are three reasons for this. (1) Shallower and deeper bypassed productive zones are often re-developed. (2) New well completion, treatment and production techniques and secondary recovery can lead to greatly increased field production. (3) Oil and gas prices have increased over time.
Dramatic Upside Potential.
The primary reason that many of the world’s largest and most sophisticated investors continue to invest billions of dollars every year to drill oil and gas wells is the dramatic upside potential of a big discovery; finding an oil and gas field. It is the huge potential of new field discovery wells that sets oil and gas investments apart from all others. Oil and gas companies regularly complete new field discovery wells where there is an extremely high ultimate return. For example, a gas field with 100 billion cubic feet of reserves has $300 million of un-discounted reserves at $3 per thousand cubic feet (Mcf). A single well in a field may have reserves of 3 to 15 billion cubic feet of gas. Which at a natural gas price of $3.00 per Mcf, it has a gross value of $9,000,000 to $45,000,000 (nine to forty-five million dollars) for one well? Then all subsequent wells drilled in that field, to that newly discovered pay zone, are now not high risk exploration wells but low risk developmental wells. Furthermore, it is at this point that the real profits are now realized, by drilling low risk offset development wells, in a now known reservoir.
Increasingly Widespread Liquidity.
Major Oil and Gas Property Auctions first appeared in the late 1980’s and have grown into a ready marketplace in which to buy and sell oil and gas properties. Prior to the exchange auctions selling an oil and gas interest was extremely difficult and time consuming. Several major auction companies, such as the Oil & Gas Journal Exchange, Oil & Gas Asset Clearinghouse and Producing Property Exchange, conduct exchange auctions through out each year. Auctions are held almost monthly, at locations in Houston, Dallas, Midland, Tulsa and Oklahoma City. Exchange auctions can be attended in person or on-line via the Internet. Major oil companies, Independents and individuals utilize these auction markets to sell and buy properties, ranging from multi-well packages to fractional interests in a single well, including royalty, overriding royalty and working interests. At typical auctions’ tens of millions of dollars will change hands. In addition to a stable auction marketplace to sell oil and gas interests, the worldwide Oil and Gas Futures Market affirm daily, a dollar value for oil and gas production and reserves.
Oil and Natural Gas…Physical and Political Safety.
One attraction of oil and gas for foreign investors is the physical invulnerability of oil and natural gas reserves. Oil and natural gas are imbedded in reservoirs of rock thousands of feet under the ground. Safely buried there for millions of years, it cannot deteriorate, it cannot easily be stolen, and it cannot be destroyed even by bombs. Part of World War II was fought on the Wittenberg gas field in Germany. After the war, a major oil company re-drilled the field and is still producing natural gas as it has since the 1920’s. Onshore oil and gas properties and reserves in the United States are both physically and politically safe in a troubled world and furthermore they are the world’s finest asset in the world’s safest place.
Federal Income Tax Benefits.
Ownership of oil and natural gas properties is not a tax shelter; however, there are tax benefits associated with re-completing and owning oil and natural gas properties. We view this investment as an economic opportunity with some tax related issues, some of which tend to increase the investors after tax net return. About 60% to 75% of an investment in an oil and gas drilling and/or re-completion project may be deducted against an investor’s other income in the year it occurred on his tax return. This is a one-time lump sum deduction primarily for the intangible costs, expenses and fees. The deduction may be legitimately taken even for prepayments made at year-end if they are properly executed. Fifteen percent (15%) of the oil and gas income generated from successful wells is deductible from federal taxable income. By the utilization of the depletion allowance, which may be subject to certain limitations. The depletion deduction on the returning oil and natural gas income are usually permanent. Unlike some other tax incentives, there is usually no non-cash taxable income (”phantom income”)
Many experienced oil and gas investors permanently avoid federal income tax altogether by “reinvesting” their oil and gas income; that is, by continually reinvesting it in new oil and natural gas projects. In this way, they get a compounded growth of their oil and gas income in the ground tax-free forever. Few independent oil companies ever pay much income tax. As with all investments, each investor is urged to consult their own advisors as to the benefits an investment in oil and natural gas may have regarding the federal income tax consequences and how it may apply to their individual tax situation.
The Power of Oil.
Oil and natural gas have proven time and time again to provide safe long-term economic value, as easily valued commodities that are the most essential basic commodities of the worlds’ growing industrial societies providing fuel, power and feedstock. So great is the economic power of oil that it has propelled relatively obscure countries and even entire regions to commercial and financial preeminence. Oil and gas are the largest business in the world. Of the top companies in the Fortune 500, oil companies rank in the top. Exxon’s net income alone was greater than the sales of more than half of the Fortune 500. Of the richest 490 people in the world featured in Forbes 2001 Billionaires Issue, 33 billionaires, worth a combines $69.6 billion, had their origins in oil or natural gas. Fueled by rising worldwide energy prices, black-gold billionaires are seeing a surge in profits. Today, the person who owns a relatively small natural gas well or two with recoverable reserves 500,000 Mcf of natural gas is a multi-millionaire. A little oil and natural gas can be worth a lot of money.
Black Gold… An Inflation Hedge That Delivers Cash Flow Even in a Depression.
Oil and gas are the ultimate defensive investment. As gold, oil and gas are an excellent hedge against inflation, however unlike gold and other inflation hedges, oil and gas will deliver a cash flow even in a depression. It is the only tax investment still available to individuals that is protected, no matter which way the economy moves. Oil and gas is a consumable basic commodity related to survival. As with wheat, oil and gas consumption continue at a relatively high level even in a depression. From 1929 to 1933, the price of petroleum products* dropped 56% but production of petroleum products dropped only 20%. Unlike wheat, however, the monthly cost of producing an oil and gas well is small compared to its income. *See J.E. Esty, Business Cycles (New York 1941)
Why Invest in Oil and Natural Gas?
Simply stated, there currently exists an evolving global energy supply and demand shift. World wide demand is increasing and will continue to do so in the future. This increasing demand is being driven by two basic factors.
First, the transformation from communism to capitalism, in eastern Europe and southeast Asia, combines with their inexpensive labor force and their currently developing emerging markets are attracting investment capital to these former communist countries. Their citizens, which now has access to the rest of the world, strongly desire to own and enjoy many of the mechanical convinces, such as cellular telephones, sophisticated entertainment systems, household appliances and automobiles the western world has enjoyed for years. These new worldwide markets now require an ever increasing energy supply to produce, manufacture, transport and operate these goods.
Second, the ever increasing world population growth. Simply stated more people require more goods and services, and therefore more and more energy is required to manufacture, transport and operate these new and additional goods and services.
Demand for Electric Power is Escalating.
The demand for power is escalating with the increased use of computers and electronic devices, as well as for winter heating and summer cooling. To meet this demand, electric utilities are building new gas-fired combined turbine generator power plants, boosting the year-round demand for natural gas. As a result, owners and producers of natural gas will benefit in the US, which is the world’s largest market.
Domestic Natural Gas Prices Remain High.
The domestic natural gas market remains strong. More and more electric utilities are looking to natural gas as an energy source, in which to fuel the new gas-fired combined turbine generator power plants being installed through out the US.