Oil & Gas Investing > Investing Frequently Asked Questions (FAQ)

The following questions and answers relate to the general attributes of investing in the oil and gas business and certain related practical matters. New questions can be added if there is a general benefit to or if it will create a better understanding for, our visitors and members. Kindly look for answers to your questions here before using support - Thanks!

1) Why should I consider investing in the exploration for and/or owning of oil and gas reserves and production?

For most people, investing in oil and gas is about achieving higher financial returns than can be made in most other investments. For many people, investing in oil and gas is about reducing personal or corporate tax liability and turning all or part of that liability into a cash flow investment. For all, ownership of a high value asset provides the opportunity for portfolio growth and capital appreciation.
Energy is the life blood of the world economy. There are many different forms of energy to invest in, but today, the most widely used and vital source of energy are the petroleum hydrocarbons we call “oil and natural gas”.

Oil and gas resources benefit from an incredible market demand and create, in aggregate, the worlds’ largest cash flows. Participating in private independent projects, providing the investor with direct ownership in oil and gas properties, can establish a monthly cash flow to the investor/owner derived from the sale of produced oil and gas. Monthly production revenues derived from the more successful ventures can be extremely significant and substantial. Oil and gas well production streams can and often do extend for decades and result in multiplying the money invested several times.

Oil and gas investments obviously serve as a hedge against rising energy prices. For anyone seeking diversification in their investment portfolio; the significance and broad effect of oil and gas ownership is too great to be ignored.
Also, because domestic crude oil production is vital to our national security, the government provides certain special tax benefits to the oil and gas investor. These incentives were placed in the tax code by congress to make participation in oil and gas ventures more attractive by lessening financial risk and enhancing ultimate financial returns on investment, thus creating perhaps the best tax advantaged investment.

2) Should an investor focus on oil well investments or gas well investments?

We like both. Many wells will produce both oil and natural gas simultaneously. Both products benefit from an insatiable worldwide demand. Both types of properties can make lucrative investments and enjoy the same tax benefits. Many investors and production companies simply seek a balance between the two.

3) What kind of income could I reasonably expect?

Of course, your income is proportional to the amount of interest that you acquire and the amount of oil and gas production that is attributable to that interest. Net income is also directly affected by the market price for oil and gas and the operating expenses (sometimes called “lifting costs”) involved in operating a producing property. Typically an investor can attain any kind of income level he/she desires if the appropriate investment is made. Please refer to our oil and gas income calculator in the left hand column for examples of potential income.

4) If I invest, how do I get paid back?

Every member (investor) of the joint venture is required to sign a division order, which is basically a contract for the sale of oil or gas, by the holder of a revenue interest in a well or property, to the purchaser. Generally, the state, which licenses the crude or gas purchaser, mandates that severance tax be deducted by the crude oil or gas purchaser, before the revenue is distributed to the well operator.

Proceeds after severance tax deduction are received by the operator about 30 days following the close of any producing month. The operator’s accounting staff or his accounting firm then deducts the lease operating expenses for the subject property and disperses the revenues monthly to the investors proportionate to their owned net revenue interest.
Because the state derives huge tax revenues from oil and gas severance taxes, the entities that handle production and revenue are heavily regulated and/or licensed, and frequently audited.

5) If I invest, then what exactly do I own title to?

In a Joint Venture program, you essentially own a pass through interest in the Joint Venture. The Joint Venture holds title in the oil or gas well property and the investor owns exactly the same Joint Venture interest. Revenue and expenses “pass through” to the investor.

6) When does the investor start sharing in the returns from oil and natural gas production income?

The better programs have cash distributions beginning about 90 days after the well(s) are drilled and completed with production established. There are several regulatory requirements to be performed, ownership title is updated to the date of first production, division orders are required to be signed and returned, and the revenue distribution accounting system is set up during this time period; all required prior to release of funds. Upon completion of these matters, initial revenue is disbursed and should continue, on a monthly basis, as long as there is commercial production sold from the property.

7) Why does the amount of my payment vary from month to month?

Production rates will vary naturally and are rarely exactly the same, day to day. As crude oil and natural gas posted prices rise and fall and monthly operating expenses vary; your share of revenue will fluctuate proportionately. Workovers and well downtime can also contribute to irregular payments. Production from an older property may diminish to a point where oil may be shipped only every two or three months.

8) What is the difference between a royalty owner and a working interest owner?

A royalty owner is that person(s) who owns title to the minerals in the subsurface which he/she leases to the oil company. As part of the lease contract, the mineral owner retains a “royalty” out of all oil and gas produced under the lease. This royalty is exempt from and does not pay any of the costs of drilling, completing or operating the well, but does pay state severance tax on production at the same rate as every interest owner.

A working interest owner owns interest which is created by the oil and gas lease. This interest has the exclusive right to explore for oil and gas and is responsible for 100% of the costs of drilling, completion and production if any (commercial) oil and gas is found. A working interest owner does not receive “royalty payments” (because they are not the true mineral owner), but receives oil and gas production revenue “net” after royalties are paid, hence the term, “net revenue interest.”

9) Why would you sell part of your project to investors? If it is as good as you say it is, why don’t you borrow money from the bank or partner with other oil companies?

From the earliest days of the American oil industry, oil companies and operators almost always sold part of their oil and gas prospects in order to spread risk and enable their company to be involved in a greater number of properties. Companies like Texaco and Gulf Oil started as a group of investors funding new drilling wells in the Spindletop Field near Beaumont, Texas in 1901. This continues to be a standard operating procedure for almost all companies. Rather than relying on borrowed money from banks, which are often fickle and frequently impose restrictive business requirements; SPXCO prefers to joint venture with its pool of investors for the exploration and development purposes.

10) How much does a joint venture manager or operator receive in comparison to the investors?

In a typical industry project, the operator (Joint Venture manager) generally retains 25% working interest or more. It is usually up to the discretion of the operator as to how much they want to sell to partners. As a working interest owner, SPXCO shares proportionally in both the operating expenses and revenues and has the same rights and responsibilities as any other joint venture partner. As the managing joint venturer and/or operator, SPXCO takes on additional obligations and functions for the group, under the joint venture agreement and joint operating agreement.

11) Aren’t all the good properties already owned by big oil companies and everything left over is of low quality, with little hope of ever making any money?

Actually, the case is absolutely the opposite. Throughout history, the smaller, independent companies have been more aggressive and enterprising and have made the majority of exploration discoveries, at least in North America. Expanded development, like the oil and gas industry itself, is very capital intensive. It is not uncommon for an independent to make a field discovery, and because of its lack of capital, to be unable to secure the entire field and therefore the major oil companies with larger capital resources are often able to move in and acquire the lion’s share of an oil field or a play and/or to buy out the independent companies’ position. Independent companies typically can compete with the major oil companies in every aspect from personnel to technology with the exception of the amount of capital resources it can bring to bear on a project.

12) Is it true that the major oil companies, like Exxon, own all the oil and gas in our country?

Absolutely not! There are several thousand independent oil and gas producers. While independent producers aren’t vertically integrated with their own refineries and service stations; independent producers explore for and produce two-thirds of America’s
natural gas and roughly forty-five percent of the crude oil. Many of these independents operate properties which are partly owned by investors just like you.

13) What kind of oil and gas investment is the most conservative?

Ultimately, the most conservative investment is to buy existing oil and gas production, but you pay a premium for this and typically forfeit many tax benefits. Exploration risk can be reduced by drilling in mature, well-defined, producing oil and gas fields or trends. Today, many see unconventional resource plays as both very conservative and very lucrative since they are producing the highest statistical success rates ever seen in oil and gas exploration.

14) Should investors purchase stock in publicly held oil and gas companies, or invest directly in oil and gas wells?

Portfolio diversification and balance often includes both direct ownership of producing oil and gas wells in addition to publicly traded stocks of energy related companies. However, stock investments are at the mercy of the stock market and are subject to double taxation; once at the corporate level and then at the individual owner’s level. As well, for investors who want significant cash flow income, direct ownership of oil and gas is perhaps the only way since it typically requires an impossibly large investment in publicly traded stock to receive a significant cash flow from the typically small dividend payments.
Direct ownership in programs that explore for and find oil and gas reserves allow investors to realize the value of the oil and natural gas sold on a monthly basis, in addition to receiving outstanding coincident tax benefits. Long term growth and capital appreciation aspects of investing are also preserved with direct ownership.

15) Why does the government provide special tax treatment to the oil and gas industry?

Oil and Natural gas from domestic reserves help foster energy independence 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 of any venture. These incentives are not "Loop Holes" -- they were specifically placed in the Tax Code by Congress to make participation in oil and gas ventures one of the best tax advantaged investments by lessening financial risk and enhancing actual returns on investment. Oil and gas resources are extremely important to our country’s security and economy. While the energy business itself represents only 4% of the U.S. economy, just try running the other 96% without it!!

16) Is the investor required to assume risk, to qualify or earn these tax advantages?

An investor is required to assume some risk and liability for his investment. The IRS tax code requires that investors meet the “at-risk” rules in order to qualify for the write off of the investment against active income such as salary, interest, rents and other investment income. In general terms, investing in oil and gas joint ventures is similar to the investment and risks many take in their owned businesses. Indeed, it is just another business. Insurance coverage(s) maintained by the joint venture and required of all contractors and vendors significantly ameliorates any risk to the venturer.

17) What is an independent (oil company)?

The basic definition of an independent is a company that is not vertically integrated and which received all or nearly all of its income from oil and gas sold at the wellhead. They are exclusively in the exploration and production segment of the industry, typically with no marketing or refining within their operations. The tax definition published by the IRS, states that a firm is an Independent if its refining capacity is less than 50,000 barrels per day in any given day or their retail sales are less than $5 million for the year. Over the last decade, the number of independents (broad definition) has decreased from over 10,000 to approximately 7,000 while the number of drilling operators has fallen from over 5,000 to approximately 2,000.

This is opposed to the “major” (integrated) oil companies which explore for, drill, produce, refine, and ship and market oil and gas products, while owning and controlling all steps from the wellhead to the end-user.

18) What is “conventional” oil and gas exploration and development?

“Conventional” oil and gas development is what has been the norm for almost the entire first century of oil and gas exploration. In essence, it is the “search” for oil and gas that has migrated from its source into a “trap” and preserved there by an impervious “seal”. Such reserves were located using various subsurface geological techniques, geochemistry, geophysical, and other means. Based on the success or failure of the methods used in exploration, commercial results were often expressed as a “success rate” in a percentage which has improved dramatically over the years with the use of enhanced technology.

19) What is “unconventional” oil and gas exploration development?

Unconventional oil and gas development is the development of petroleum hydrocarbons from known source rocks, as opposed to finding where it has been trapped while migrating. Source rock or formations have generally been known entities for years but were not considered “reservoir quality” rocks usually because of low porosity or water content. Recent technological advancements have made unconventional resources the leading contender in the race to increase world oil and gas production, with unconventional plays expected to provide up to 80% of the increase. Thus, the “future” is in unconventional resources. Unconventional reservoirs include, but are not limited to, oil and gas shales, tight gas formations, coalbed methane, ultra-deep gas, methane hydrates, and heavy oil tar sands.

20) What do you mean by Peak Oil?

Peak Oil is a broad and contentious subject. There is a growing consensus that, in aggregate, world oil production has peaked in late 2006 or will soon reach a peak in production, from which point, the world will not ever reach that production level again.
This is not to imply that the world is running out of oil soon, but that, as world demand continues to increase there will not be enough incremental oil to satisfy the growing demand. Accordingly, it follows that significant increases in the value and price
of energy products will take place and the owners of the oil and gas will benefit from this trend. For further discussion, see our “peak oil” section under “Links”.