Home > Oil and Gas
Oil and Gas
Producing oil and gas Investments are a 1031 exchange Alternative
oil and gas royalties and working interest lease ownership may be an option for real estate investors looking to conduct a 1031 exchange. Under certain conditions, Oil & Gas programs may qualify as "like kind" property, thus providing a 1031 exchangepossibility for those investors looking to reinvest their proceeds from the sale of investment real estate, while deferring the capital gains tax. oil and gas investments are for those investors seeking passive investments, income and, above all, diversification.
Click on the following links to learn about:
oil and gas Mineral 1031 exchanges Explained
What are Royalties?
What is a Working Interest?
Benefits of oil and gas Investing
Why Invest in oil and gas?
Risk of oil and gas Investing
oil and gas Production working interest and Royalty Interest
oil and gas Industry FAQ
TIC Advisors has relationships with companies who offer either a fractional interest in working interest production or direct royalty interest ownership, both of which may qualify as "like kind" under 1031 exchange requirements. Either of these interests provides a 1031 exchangereplacement property option for investors looking to reinvest proceeds from recent real estate sales and allow diversification options for real estate investors.
oil and gas Mineral 1031 exchanges
Mineral Interests:
"Working" or "royalty interests" may qualify as "like kind" property and if so, can be 1031 exchangeD into any other "like kind" properties, including another working or royalty interest, office building, apartment building, retail building, etc.
The IRS may disallow an 1031 exchange if the royalty interests or surface rights are retained. It is also important to note that production payments and substantial equipment transfers (more than 15%) do not qualify for a 1031 exchange. Please contact a qualified tax attorney for specific advice on these issues.
oil and gas Intangible Drilling Costs:
When 1031 exchangeing out of a working interest into an income producing property (retail or office building), there are Intangible Drilling Costs (IDC) that must be recaptured.
What are Royalties?
Generally, minerals, royalties and overriding royalties' owners receive revenues from the production of oil and gas without paying the drilling or monthly operating expenses. Overriding royalty interests are created from the working interest and take a percentage of revenues from oil and gas production and expire upon the termination of production.
Royalty investment creates a chance for investors to participate in an industry without the normal risks associated with exploration, inactive wells, and unsuccessful drilling. Royalty investments normally avoid the unpredictable aspects of new production investments.
What is a Working Interest?
A working interest is a leasehold interest which allows the lessee the right to search for and produce oil and gas on a parcel of land and receive a portion of the proceeds of the oil and gas produced. In a typical program, each fractional owner has the same rights as a single owner and can usually subdivide or offer for sale their ownership interest on the open market.
Why Invest in oil and gas?
The secret to asset appreciation is to buy in the path of growth.
Oil is one of the most important natural resources known to mankind. For most societies in the world, oil is the principal natural resource that fuels their economies.
Then why, in this great age of communication and technology, do we need to be concerned about a natural resource like oil? Simple. Nearly 98% of everything you have or do is in some way related to crude oil. Heat for your home, gas for your car, 2 liter plastic bottles for pop, and petroleum jelly are just a few examples of products created from crude oil.
The United States has the greatest standard of living in the world, as well as the largest economy. Why? Because we have always tried to maintain control over the supply, as well as price, of oil. Over the last 10 years, the U.S. economy has undergone the largest economic expansion in history and cheap oil has fueled this unprecedented growth. Unlike the 1970s, when the U.S. was held at bay by OPEC withholding oil production for political reasons, the growth of the oil industry during the 1990s, and beyond, will be more likely be determined by the laws of supply and demand.
As democracy and capitalism are spreading around the world, global oil consumption is at record levels. Throughout Latin America, Russia, India and Asia, economic growth is accelerating at a remarkable pace; much faster than anything we have seen in the U.S. Recently, Forbes described the development now exploding across Asia:
"You can almost smell the money in Shanghai, Bangkok, Kuala Lumpau or just about any East Asian commercial center outside Japan these days. Traffic snarled, construction booming, glitzy shopping malls showing the latest Hollywood movies... These formerly traditional societies, stagnant for centuries, are exploding into the modern capitalist world and spawning vast new middle classes with a taste for consumer goods and the means to indulge that taste. Healthy economics generate great wealth, and Asia is churning out billionaires as though on a conveyor belt."
--Forbes
In these countries, more than two billion people, or more than 40% of the world's population, are suddenly entering the age of consumerism. Thanks to American movies, TVs and VCRs, they have seen what the rest of the world has and they want it all.
"They want McDonald's french fries. They want Coke. They want Levi jeans. They want Caterpillar tractors. They want cars, cameras, mouthwash, homes, toothpaste, Tide, aspirin and ten thousand other products we take for granted. "In vast regions of these countries, they're starting from the raw basics of modern life. They need electric power, running water, sewage treatment plants, bridges, tunnels, roads, cities -- you name it. "And oil is the one commodity absolutely essential to this tidal wave of global growth. It's literally the blood supply of capitalism. If you're a developing country, you need all the oil you can get to drive your trucks, your cars, your planes and ships. You need oil to run your factories, machines and power plants so necessary to a modern industrial economy. "What we're seeing is the first simultaneous, worldwide economic expansion since the late 1970s. But this time, many newly industrialized countries are joining the party and importing an unending procession of super-tankers laden with black gold."
--Personal Finance
Benefits of Oil & Gas Investing
POTENTIAL FOR INCREASED MONTHLY CASH FLOW: oil and gas programs may increase cash flow and total return to a traditional investment portfolio.
For the individual who is looking for higher returns than the average investor, and is willing to assume a commensurately higher degree of risk, oil and gas programs are a possible solution.
MANAGEMENT FREE: Professional Management.
Like Tenant-In-Common ownership, a professional operator with a proven track record is very important. A good Oil & Gas investment depends on solid management, good engineering, and a thorough understanding of the production life of the wells. An experienced operator will have the organization, professionals, and systems in place to properly analyze and operate the investment.
INVESTMENT PORTOLIO HEDGE: oil and gas ownership provides a hedge against the impact of sustained high or rising energy prices on other asset classes.
oil and gas have a low or negative correlation to other asset classes (equities, bonds, Real Estate, etc.) creating a hedge in a diversified portfolio.
LESS STRINGENT 1031 REQUIREMENTS: Direct oil and gas investments do not have to comply with Revenue Procedure 2002-22.
Oil & Gas investments generally do not have to comply with some of the strict requirements of Revenue Procedure 2002-22, making it easier for investors to find a 1031 exchange option.
REDUCED EXPOSURE TO REAL ESTATE: oil and gas can help reduce many 1031 exchange investors exposure to real estate.
Many investors are over allocated in real estate. Investing in oil and gas can help reduce exposure to real estate by investing in a global commodity that is not solely dependent on the U.S. real estate market.
FLEXIBLE LIQUIDITY OPTIONS: Investor controls exit strategy.
An investor can sell directly to another investor or liquidate the investment in the secondary market. Each year, hundreds of millions of dollars of oil and gas interests are bought and sold through online auctions, third party divestment companies, and private sales.
INVESTMENT SIZE FLEXIBILITY: Match your investment.
Oil & Gas production can be acquired on a fractional basis, typically with a small minimum investment. Large producing fields can be sold to hundreds of investors; each individual investor owns a fractional interest in all of the producing wells.
REDUCED CONCENTRATION RISK: Diversification.
oil and gas assets are typically offered nationwide, and often consist of ownership in hundreds and often thousands of producing wells, on hundreds or thousands of acres of land in multiple oil and gas regions in the United States.
Risk of oil and gas Investing:
Prices of oil and gas are highly volatile
The value of Oil & Gas investments are based on the potential production and the price of Oil & Gas as a commodity. The income and value of the Oil & Gas interest will fluctuate depending on the then-current domestic and foreign reserves, oil and gas prices, and demand for oil and gas production.
Reserve estimates are not an exact science
There are many uncertainties inherent in estimating quantities and values of reserves. This makes the task of projecting future rates of production or future contemplated development difficult.
Difficult to Leverage
Unlike real estate, Oil & Gas is very difficult to leverage. 1031 exchange investors needing to replace debt in their 1031 exchange will have a difficult time acquiring only Oil & Gas interests.
Alternative Energy Sources
Oil & Gas investments will likely decrease if new areas of exploration are discovered, alternative energy sources are developed or supply begins to exceed demand.
Production expenses
Production expenses will most likely not directly impact the proceeds received by Royalty owners, but they do influence the operation of the well. For example, a possible result of a dramatic increase in production expenses is a reduction or cessation of well production, which could have an adverse affect on an investors yield.
While there are generally no drilling risks, Oil & Gas wells do require maintenance, and an Owner of a Working Interest will pay a pro rata share of the expenses associated with maintaining the wells.
Tax Treatment of oil and gas Production working interest and Royalty Interest
Tax Treatment: Investors in Oil & Gas production can deduct against income the greater of "cost" depletion or "percentage" depletion. 1031 exchange Investors often transfer a low basis into Oil & Gas production and will typically use "percentage" depletion. "Percentage" depletion is calculated as a percentage of the revenue generated by the wells. The cost or adjusted basis has no bearing on the amount of "percentage" depletion allowed. As a result, depletion deductions can exceed the cost or adjusted basis. Unlike depreciation of real estate, if the investor sells Oil & Gas production, there is no recapture of depletion taken.
Oil and Gas FAQ
What does the term "Peak Oil" mean?
"Peak Oil" is a worldwide concern. Chief Geologist Dr. King Hubbert discovered in 1959 that once the world oil recovery rate begins to crest beyond peak levels, the world will produce less and less oil with each successive year.
But can't we just cut back on our oil usage in this country and build back up our oil reserves?
Yes and no. Certainly if this country were to aggressively begin to conserve its use of petroleum and related products we would stave off the effects of "Peak Oil". But oil is a worldwide issue. First, to this date there appears to be no real conservation movement underway. We in the United States are still buying trucks and SUV's getting ridiculously low miles per gallon. The U.S. leads the world in the use of fuel.
Secondly, oil is a worldwide product. The emergence of China and India is sucking up more and more oil in order for their country's business sectors to operate. Each year, it is more and more evident that the huge machine that we have built cannot sustain itself in its present form. Europe and Japan are completely oil dependent as they are on the large list of countries that are considered "net importers" (meaning they use more oil that they produce). The list of countries that are now considered "net exporters" (they use less oil than they produce) is very short.
Lastly, even if we could find a miracle "cure" for our lessening oil supplies and we could offer it to the world to eliminate our dependence on crude oil, the result would be a cataclysmic worldwide depression that might change the planet forever. The oil industry is a multi-trillion dollar business of refineries and transmission lines including multiple lines of transportation. How could our planet sustain such an economic loss?
In short, the world has been consuming more oil while it is drilling and extracting less oil for a long time. These two trends cannot last long. The supply and demand curves will collide leading to *huge increases in the price of oil and oil related petroleum products. It is these basic macro-economic trends that have caused some experts to realize that we must maintain our oil dependence while realizing that the price we may pay could be costly.*
What other products require oil to create?
Petroleum is used to manufacture an enormous number of products for your life. Less than 20% of all recovered oil is used for any type of fuel. Over 30% is used for the creation of food via fertilizers. Nearly the same amount is used to manufacture plastics. If you were to walk through your home and office, you would become shortly overwhelmed by the thousands of items you use everyday that would not be available to you without our access to oil. In fact, everything we now buy today represents a measurement of energy in order to create and then for us to consume. Below is a short list of a few everyday items made from oil. How many could you do without?
Clothing Ink
Heart Valves
Crayons
Parachutes
Telephones
Enamel
Transparent tape
Antiseptics
Vacuum bottles
Deodorant
Pantyhose
Rubbing Alcohol
Carpets
Epoxy paint
Oil filters
Upholstery
Hearing Aids
Car sound insulation
Cassettes
Motorcycle helmets
Pillows
Shower doors
Shoes
Refrigerator linings
Electrical tape
Safety glass
Awnings
Salad bowl
Rubber cement
Nylon rope
Ice buckets
Fertilizers
Hair coloring
Toilet seats
Denture adhesive
Loudspeakers
Movie film
Fishing boots
Candles
LP records
Solvents
Roofing
Food preservatives Floor wax
Sports car bodies
Tires
Dishwashing liquids
Unbreakable dishes
Toothbrushes
Toothpaste
Combs
Tents
Hair curlers
Lipstick
Ice cube trays
Electric blankets
Tennis rackets
Drinking cups
House paint
Rollerskate wheels
Guitar strings
Ammonia
Eyeglasses
Ice chests
Life jackets
TV cabinets
Car battery cases
Insect repellent
Refrigerants
Typewriter ribbons
Cold cream
Glycerin
Plywood adhesive
Cameras
Anesthetics
Artificial turf
Artificial Limbs
Bandages
Dentures
Mops
Beach Umbrellas
Ballpoint pens
Antihistamines
Cortisone
Dyes
Water pipes
Car enamel
Shower curtains
Credit cards
Aspirin
Golf balls
Detergents
Sunglasses
Glue
Fishing rods
Linoleum
Plastic wood
Soft contact lenses
Trash bags
Hand lotion
Shampoo
Shaving cream
Footballs
Paint brushes
Balloons
Fan belts
Umbrellas
Paint Rollers
Luggage
Antifreeze
Model cars
Boats
Nail polish
Golf bags
Caulking
Tape recorders
Curtains
Vitamin capsules
Dashboards
Putty
Percolators
Skis
Insecticides
Fishing lures
Perfumes
Shoe polish
Petroleum jelly
Faucet washers
Won't the world market solve this problem by coming up with a replacement for oil?
No. This is a very tough question for most people to come to grips with. There is no known viable source of energy harnessing creation that comes close to the combustible engine that was invented just a century ago. There are many ways to create energy but all of them ultimately require more energy to create than is returned.
I have heard about the advancement of hydrogen fuel cells as an energy replacement for oil. Does it work?
No, at least it does not right now. The idea of creating a kind of battery that never needs recharging by mixing hydrogen and oxygen in a fuel cell to produce an electric current is certainly not new. Scientists have been working on this capacity since the 1980's and while we know more now than back then about this type of energy system, the largest companies in the world involved with the research and development of hydrogen fuel cells have scaled back their staffs dramatically and have seen their stock prices crash. This method has a long way to go. There simply is no replacement for the combustible engine and the need for petroleum to be used for its operation.
How can I get the energy crisis to work for me?*
There are several methods to invest and potentially profit from the coming energy crises. Many investors simply buy stock in a publicly traded oil company. Often when the price of oil goes up, the stock will move with it provided they have oil reserves as part of their valuation.
However, investing in oil stocks is NOT the same as investing in oil. Remember, if a company has poor management, the stock may go down even if oil goes up. Recently Shell Oil revealed that they released fraudulent information on their estimated oil reserves. The resulting information caused Shell's stock to drop dramatically even while oil was climbing in value.
Some investors like to challenge the tricky world of oil futures. If you pick your timing right you can make huge money overnight. Future investors invest a little money (relatively) to make a lot. However, like in stocks, future investing is NOT investing in oil. Even during an overall upward trend environment for oil, if you guess wrong on any one down day you could lose all of your money and maybe owe a bunch more.
Finally, some investors participate in an oil drilling partnership in geographical areas known to have established oil fields. Once again there is risk involved. "Dry Holes" do happen everyday in the oil business. If you are looking for cash flow and want to avoid drilling risk find a group that specializes in royalties and producing working interest. Investing in private royalties gives access to prime royalty and overriding royalty properties with existing cash flow and documented stability and growth. These quality properties incur no monthly expense or liabilities related to additional development, making it easy to track their performance record and potential yield. The result is attractive, risk-adjusted investment performance. Investing in royalties generates monthly income with low correlation to global equity and debt markets which can enhance overall portfolio returns.
