Oil and Gas
The oil and gas industry is broken down and divided into three categories.
1) Upstream is the exploration and production
2) Midstream is the transportation of tankers and/ or pipelines that carry the crude oil to a refineries.
3) Downstream is breakdown of refining, marketing, and distribution of Crude Oil
As you can tell the main principle of the industry is to extract crude oil and then transport it towards sale. Crude oil is a mix of multiple petroleum liquids and gases in several combinations.
Throughout the years, crude oil is result of organic waste, which escapes and migrates into pores and through fractures in rocks until they are held in permeable rocks. The settling form is usually surrounded with heavy salt water lying below it and a shale rock sealing it on top forming the reservoir. When drilling takes place and the reservoir is drilled the pressure through the penetration of the reservoir allows oil to rush back up through the casing and to the surface as crude oil usually also at time accompanied with natural gas.
As soon as crude oil hits the surface it needs to be transported to a refinery where it can begin its stages of being broken down for multiple uses. The refining process has the crude oil go through a thermal distillation process that begins the break down into parts and removes any unwanted impurities. This creates a stream of results that can be used as fuel, home heating oil, jet fuel, industrial oil etc. This then leads to marketing and selling.
(Razor Resources provides clients with upstream field work.) Our firm also provides opportunity for outside investors to invest within the oil and gas industry.
Oil and Gas investing is something that Congress has provided tax incentives to stimulate oil and natural gas production by private sources. There are several significant advantages and returns for all investment opportunities. Tax benefits range from up front deductions for intangible drilling cost to tax credits that can be carried out for exploring other formations. Tax deductions are generated from the cost of non salvageable equipment and services that take place during the drilling phase, testing, and completions of the well.
Intangible drilling costs include everything but the actual drilling equipment. Usually these expense count for 65%-80% of the total cost of drilling a well and are a 100% deductible in the year incurred.
Example: If it cost $600,000 to drill a well and 75% of that cost was considered intangible, then $450,000 would be considered a deduction even if the well does or does not produce.
Tangible drilling costs are associated with actual direct cost of the drilling equipment. These expenses are 100% deductible and are depreciated over a period of seven years.
Example: From the $150,000 remaining from the previous example that would be written off on a seven year schedule.
The tax code has working interest re: oil and gas well -- not considered to a passive activity. This translates to all net losses being active income incurred in conjunction with well head production and can be offset against other form of income (wages, capital gains, and interest).*
Another tax break incentive is for small producers and investors -- also known as the DEPLEATION ALLOWANCE – whereby 15% of all gross income from oil and gas wells from taxation are excluded. This only applies to companies who produce or refine 50,000 barrels per day. Also, entities that own more than 1,000 barrels of oil per day or six million cubic feet of gas per day are excluded.
Lease cost in mineral rights, lease operating cost, administrative, accounting, and legal expenses are all 100% deductible in the year they are incurred.
Alternative minimum tax comes into play with all excess intangible drilling cost as they have been exempted as a “preference item” on the alternative tax return.
*Please consult with your own CPA for your specific accounting advice.