Understanding An Existing Oil Drilling Investment Opportunity

Overview of the project:
We are currently invested in a single well being drilled in Texas. We are about to participate in a new five well project that will be open for funding by investors very soon. Each of the five wells will be drilled similar to this single well. This article will provide some highlights of this single well project to help readers understand what they will hear about when considering an investment in oil/gas drilling. It is written for educational purposes only and is not a solicitation to invest or a prospectus.

This single well project is a re-entry into a vertical well drilled by Exxon in the mid-80s. The well was capped at that time since oil was too cheap to continue producing from the well. This investment pays for a rig to go back into the vertically drilled hole to then drill horizontally upwards of a mile through the pay zone (layer of earth where the oil and gas are known to exist from the well’s previous log report.

An overview of horizontal drilling:
Horizontal drilling is a fairly new process for drilling where the drill bit can actually be steered sideways toward the highest concentrations of oil and gas. The drill operator usually has tools allowing logging while drilling (LWD) the hole. This means the operator can see what the formations in the ground are around the drill bit to know what the move toward or away from. This provides much better odds for a successful well than simply drilling vertical wells and logging the well after it is drilled to see whether the well will be a success or not. Also, another benefit of horizontal drilling is that the wells tend to produce strong for the first five years or so and then continue producing at a slower rate over the next 15 years or so. Over the life of this well, the investor may gain significant multiples of total return on their initial investment.

Understanding how the investment is structured:
- Investors ownership: Investors have 33% working interest (WI) and 25% net revenue interest (NRI) in the well. This means they own 1/3 of the well for tax purposes, but receive 25% of the revenues generated by the well since other percentages to the land owner, lease owner, oil producer, and others involved outside of investors.

- Cost of investment: Each unit of investment costs $100,000. This provides 2.75% WI and 2.0873% NRI in the well for the investor.

- Projected return on investment: This project was initially formed when oil was selling for around $80 per barrel. Projected earnings for the investor’s $100,000 at that time was $119,808 at 200 barrels of oil equivalent (BOE) per day for $80 per barrel oil. With oil now trading about $125 per barrel, this equates to around $187,200 income or a 187% return in the first year of production. This does not count the additional tax savings granted by congress for independent producers of domestic oil and gas.

- Tax savings benefit: There is an expected additional average tax savings of $32,000. All invested funds in domestic independent oil and gas drilling ventures are deductible against all income types with the intangible drilling costs (IDC) being fully deductible the first year and the remaining tangible costs being deducted over seven years. For this project, IDC are about 80% of the project so $80,000 of the $100,000 invested is fully deductible in the first year by the investor.

- Yearly tax free income benefit: In addition to the tax deductions, 15 – 23% of each year’s income is tax free for these types of domestic oil and gas drilling ventures. With a projected first year income of $187,200 at $125 per barrel oil, the investor would receive a minimum of 15% tax free, or $28,080. If you are in a 35% tax bracket, that is a savings of $9,828 in taxes. This is additional income to you.

Putting it all together for expected 1st year return:
At $125 per barrel for oil and 200 BOE daily production, this project is projected to create $187,200 income + $32,000 tax savings (80% of invested funds from IDC 1st year deduction) + $9,828 income tax savings (1st 15% of the year's income is tax free) for a total of $229,028 the first year for a $100,000 investment. This is a projected 229% total return on the investment. As stated earlier, in general, horizontal wells provide stronger returns initially and over longer periods of time than vertically drilled wells. Therefore, this project could generate many multiples of the original $100,000 invested funds over the life of the well.

New information since the original project was put together:
Recently another major oil drilling corporation has had several similar wells in the area come in at 500 to 700 BOE daily production. If this project comes in at 500 BOE daily, the first year income would be $468,000 at $125 per barrel oil instead of the $187,200 calculated for the original 200 BOE projected daily production. That would be a 468% return on investment in the first year. Again, this does not count the additional savings from taxes. We are keeping our fingers crossed that the well comes in around this range.

Low time required for an outstanding return:
As an investor, most of your time will be spent investigating the initial investment to consider participating in a oil/gas drilling venture and funding your share of ownership in the partnership. Once invested, you can sit back and watch the monthly payment checks come in. A good return for very low overall time commitment.

Disclaimer:
Information provided in this article covers projections on a single well horizontal project. These are not to be considered actual returns. There are many factors that can cause the returns to vary from projections, including the possibility the well may not turn out to be producible (a dry hole - oil industry jargon). Each investor should always do his/her own due diligence before considering participating in any investment. This article is provided for educational purposes.

Summary:
I hope this example of a real existing oil drilling investment helps you understand some of the things I have discussed in previous articles to this blog. This is why the oil and gas can be very profitable for investors who know what they are doing and make calculated investments in this industry. I never suggest anyone invest more than they are willing to lose so seek advice of a professional if you are considering investing in oil and gas for the first time.

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Copyright 2008 Ole Cram. Ole Cram is President of Marcobe Investments, Inc., a corporation that invests in various oil and gas ventures and refers accredited investors, investment managers, financial advisors, investment funds, and others to the associated oil producer of these projects for their consideration to also participate. We are not licensed to sell any interest in a project, nor are we registered advisors. Feel free to email us at MarcobeInvestmentsInc@gmail.com with any questions, thoughts, or requests for other topics to cover in future articles.

This article was posted at Accredited Investor Blog: http://accreditedinvestortalk.blogspot.com/. Past articles can easily be found at http://www.MarcobeInvestmentsInc.com/Oil_and_Gas_Investor_TOC.html. This article is provided for educational purposes only and is not meant to be a substitute for tax, legal, financial, or other registered professional advice for your specific situation. Always seek the advice of a professional before making any related decision.

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