For Whom Is Oil & Gas Direct Investment An Appropriate Investment
Accredited investors seeking to generate income along with opportunities for upside growth, direct exposure to profit potential generated by oil and gas operations, and tax advantages, may find that an investment in the Fund is an attractive diversification option to an existing investment strategy. Investors should note that oil and gas direct investing carries significant risk and there are no guarantees that any cash flow will be achieved. Please review the offering documents relating to any investment opportunity being evaluated in full prior to making an investment including specifically any Risk Factors identified therein. ACCREDITED INVESTORS ONLY
Is A Royalty Interest Or Working Interest Better
A royalty interest means you lease rather than sell your mineral rights to the land. You dont have any control over the drilling or exploration process, but you also wont have to worry about any liability or maintaining equipment. A working interest has a greater chance for financial gain than a royalty interest. Investing in wells currently in production is safer than exploratory drilling.
There is a strong global need for oil. When investing, it is important to work with a company with long-term patterns of security. Dont look for quick trends in the market, but instead work with a company that has proven to always come out on top.
The most common ways to invest in oil include mutual funds and ETFs, stock and ADRs, futures contracts, and micro-cap stocks. While the most common types of oil investments include exploration, developing, income, and services. The financial advantages of oil investing include diversification, profit potential and tax breaks.
Tax advantages include deductions for tangible drilling costs, intangible drilling costs, lease costs, and depletion allowance for small producers are just a few examples. The upside of an oil investment is that it can last for many years as the oil well produces.
Mlp Etfs Etns & Mutual Funds
There are 3 primary ways to invest in MLPs:
Note: ETN stands for exchange traded note
The difference between investing directly in a company versus investing in a mutual fund or ETF is very clear. It is simply investing in one security versus a group of securities.
ETNs are different. Unlike mutual funds or ETFs, ETNs dont actually own any underlying shares or units of real businesses. Instead, ETNs are financial instruments backed by the financial institution that issued them. They perfectly track the value of an index. The disadvantage to ETNs is that they expose investors to the possibility of a total loss if the backing institution were to go bankrupt.
The advantage to investing in a MLP ETN is that distribution income is tracked, but paid via a 1099. This eliminates the tax disadvantages of MLPs . This unique feature may appeal to investors who dont want to hassle with a more complicated tax situation. The J.P. Morgan Alerian MLP ETN makes a good choice in this case.
Purchasing individual securities is preferable for many, as it allows investors to concentrate on their best ideas. But ETFs have their place as well, especially for investors looking for diversification benefits.
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Why Focus On Undervalued Oil & Gas
Value investors seek to buy stocks at a discount to their intrinsic value. Long-term returns show that such strategies are advantageous. Value stocks, as a group, tend to outperform growth stocks over extended periods of time. Typically, value investors perform financial analysis of numerous metrics, dont follow the herd and are long-term investors. AAIIs A+ Investor Value Grade is derived from a stocks Value Score. The Value Score is the percentile rank of the average of the percentile ranks of the price-to-sales ratio, price-earnings ratio, enterprise-value-to-EBITDA ratio, shareholder yield, price-to-book-value ratio and price-to-free-cash-flow ratio. The score is variable, meaning it can consider all six ratios or, should any of the six ratios not be valid, the remaining ratios that are valid. To be assigned a Value Score, stocks must have a valid ratio and corresponding ranking for at least two of the six valuation ratios.
I Have A Basis In My Working Interest Investment Doesn’t This Alone Allow Me To Deduct The Idcs
This was an interesting question that came up while discussing the ability of the investor to deduct IDCs with a client. The client I was speaking with thought that the basis trumped all of the other rules and that the only issue was his basis in the working interest. Unfortunately, this is not the case. Basis alone does not allow you to deduct the IDCs. While basis will come into play at some point, it is not the first hurdle to cross. The first test you will have as an oil and gas investor is the passive/active test. If you are a passive investor, basis alone will not allow you to take the deduction. In order to avoid the passive test, you will want to make sure that you own the working interest directly or through an entity that does not limit your liability with respect to the working interest . Once you have cleared that hurdle, we can then talk about basis.
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How Do You Find A Great Oil And Gas Limited Partnership Company
If you want to find a great company you must get answers to these questions:
Experience & History
Does the company have a track record of success in both boom and bust oil price cycles? Has it been in business long enough to have industry expertise and contacts?
Expertise In Exploration & Production
Does the company know how to find and drill successful wells in overlooked oil and gas reserves via new analytic, seismic and fracking technologies? Can it operate wells via improved well work-over and reservoir engineering technologies?
Viable Business Model
Does the company have a business model that can make money in either high or low-price oil scenarios? Does it have single or multi-well projects dealing with drilling into proven undeveloped reserves? Can they keep costs down while operating the wells?
Top Management
Are they movers and shakers who can make things happen no matter what obstacles arise? Are they connected with the best geologists, petroleum engineers and operators who can contribute to successful wells? Do they keep an eye on short-term and long-term factors affecting supply, demand and price? Are they highly ethical? Are their interests aligned with their investors because they have put their own money into their projects?
Of course, any company that contacts you will tell you they have all the right stuff. Perhaps they do, but you must confirm this with your own due diligence. And this wraps up our answer to your first question:
Oil Tax Breaks And Energy Infrastructure Development
The list of tax breaks effectively illustrates how serious the U.S. government is about developing the domestic energy infrastructure. Perhaps most telling is the fact that there are no income or net worth limitations of any kind other than what is listed above . Therefore, even the wealthiest investors could invest directly in oil and gas and receive all of the benefits listed above, as long as they limit their ownership to 1,000 barrels of oil per day. Virtually, no other investment category in America can compete with the smorgasbord of tax breaks that are available to the oil and gas industry.
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Small Producer Tax Exemptions
This is perhaps the most enticing tax break for small producers and investors. This incentive, which is commonly known as the “depletion allowance,” excludes from taxation 15% of all gross income from oil and gas wells. This special advantage is limited solely to small companies and investors. Any company that produces or refines more than 50,000 barrels of oil per day is ineligible. Entities that own more than 1,000 barrels of oil per day, or 6 million cubic feet of gas per day, are excluded as well.
Before You Invest In Oil & Gas Master Limited Partnerships
The chase for yield has investors asking lots of questions about MLPs Master Limited Partnerships. Todays editorial is an 8-point checklist every investor should know before adding MLPs to their portfolios, and comes from guest editor Brian OConnell.
Can you afford to miss out on an investment opportunity that has returned 66% to investors over the past five years and has beaten every major market index in 11 of the past 12 years?
Thats the promise, and the potential of Master Limited Partnerships , an energy investors answer to a long-unanswered question how can I get income and growth appreciation out of a single investment and earn a big tax break in the bargain?
When it comes to MLPs, the positives have outweighed the negatives, but that doesnt mean you should jump in eyes closed and head first.
Before you pour cash into an MLP, take these tips with you first:
Master Limited Partnerships Defined
Instead of shares, MLPs offer investors units, and payouts arent called dividends, theyre called distributions. In essence, MLPs offer the tax advantages of limited partnerships with the asset growth benefit associated with common stocks.
Tax-wise, MLPs are treated differently from stocks and bonds, and are generally treated more favorably by the Internal Revenue Service. Taxes are paid by MLP unit-holders, on a pass-through basis.
Why MLPs?
Statistically, MLPs offer
Historical yields of up to 10%
Demand for Oil Drives MLP Growth
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Brokers Take Advantage Of Investors By Recommending Unsuitable Oil And Gas Limited Partnerships
Oil and gas limited partnerships are also accompanied by a great deal of upfront fees charged to the investor. While these fees include a great deal of highly unnecessary expenses, most of them are paid to the recommending broker as their commission for brokering the trade. A brokers commission for these products can sometimes even come out to a whopping 10 percent of the investors principal investment.
This commission is compounded with other upfront fees that can almost lower an investors principal by 17% right off the bat. When an investors principal investment is lowered that significantly, seeing any returns on their investment becomes incredibly difficult.
This fact, along with the incredible risks and illiquidity associated with oil and gas limited partnerships, is often omitted by recommending brokers trying to obtain the incredibly high commission. Many brokers pitch these investments with a promise that the general partner has stumbled upon something great. They might also bring up that significant dividends outweigh any threat of risk however, they often leave out the fact that these dividends are entirely dependent upon the partnerships success and that they can be yanked away from the limited partners at any moment if the value of the partnership begins to fall.
Mlp #: Nextera Energy Partners Lp
- 5-year expected annual returns: 14.2%
NextEra Energy Partners was formed in 2014 as Delaware Limited Partnership by NextEra Energy to own, operate, and acquire contracted clean energy projects with stable, long-term cash flows. The companys strategy is to capitalize on the energy industrys favorable trends in North America of clean energy projects replacing uneconomic projects.
NextEra Energy Partners operates 34 contracted renewable generation assets consisting of wind and solar projects in 12 states across the United States. The company also operates contracted natural gas pipelines in Texas which accounts for about a fifth of NextEra Energy Partners income. Following the IPO, NextEra Energy held 82.6% of NextEra Energy Partners.
On October 28th, 2022 NextEra Energy Partners released Q3 results. It grew distributions per unit approximately 15% year-over-year and completed its previously announced acquisition of approximately 230-megawatt, 4-hour battery storage project from NextEra Energy Resources. Management announced year-end 2023 run-rate adjusted EBITDA and cash available for distribution expectations, up roughly 23% and 12%, respectively.
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What Is An Oil And Gas Partnership
In simple terms it is a business entity owned and operated directly by its investor partners. There is one investor or group who is designated as the General Partner, and it manages the limited partnership on behalf of all partners. They oversee the actual drilling and production activity. If all goes according to plan , the investors increase their net worth and monthly income. In the worst case scenario , they can write off most of the investment for tax purposes.
Investors own what is referred to as a working interest in the well, which is usually a percentage of actual ownership. They share in the revenue, pay operating and maybe future work-over costs in proportion to their ownership. Theoretically they have a liability for costs incurred by unforeseen events, but because the limited partnership and their contracted service providers have insurance, this is rarely an issue. .
Investing in an oil and gas limited partnership is much different than investing in Wall Street investments. There is no resale market that trades in limited partnerships, so if an investor wants to sell his working interest, it will take time and approval of the General Partner.
Master Limited Partnerships Definition
The IRS requires that MLPs make at least 90% of their revenue from real estate or natural resources.
Master Limited Partnerships feature two types of partners: General Partners and Limited Partners . The general partner manages the MLP, generally has a 2% interest, and receives payments based on the MLPs performance. Investors serve as the limited partners. They have no say in management but receive distributions. Individual shareholders are called unitholders.
There are riskier versions of MLPs that only trade privately. Privately traded MLPs are unsuitable for the vast majority of investors. Brokers who recommend non-traded MLPs may be suggesting an unsuitable investment in violation of FINRA Rule 2111.
There are three basic types of natural resource MLPs:
- Upstream Funds Upstream funds own mineral and royalty rights. They also own exploration and production operations.
- Midstream Funds Midstream funds focus on gathering, processing, transporting, and storing oil.
- Downstream Funds Downstream funds are involved in refining and marketing oil.
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Before You Buy An Mlp:
Midstream MLPs typically come with big commissions for brokers and financial advisors. Brokers may claim that MLP units come with returns as high as 7% or 9% while those returns may be possible, they are far from guaranteed. Your broker should always inform you of any risks associated with an MLP unit.
If you believe a broker-sold you an unsuitable share of an MLP, contact a securities lawyer to figure out the next steps to get your money back.
How Should I Set Up A Working Interest In An Oil And Gas Investment
If you are an investor looking to take advantage of IDC deductions during the drilling phase, you will want to make sure that you own it directly or through an entity that does not limit your liability with respect to the oil and gas property. This will allow you to treat the investment as active rather than passive, regardless of your participation.
If you do plan on being active in the entity that owns the investment, you will want to consult with your legal counsel to make sure you have afforded yourself liability protection. By being an active participant, you will not need the exclusion provided by Reg § 1.469-1T.
If you intend to raise capital from investors, you will want to make sure that you allow the investor the opportunity to take advantage of the deductions during the drilling phase. In our experience, we most often see this done through a limited partnership that has both limited and general partnership units. Law firms that are familiar with oil and gas partnerships will know exactly how to set these up. Typically an LLC would not be the entity of choice if you have investors.
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What Types Of Investors Might Be Interested
Although not for everyone, thousands of individuals each year invest in limited partnerships. They must be an Accredited Investor, which generally means a net worth exceeding $1 million or an annual income greater than $200 thousand . So, they are often mature and financially successful.
Accredited investors, because of their higher tax bracket are able to take advantage of significant tax write-offs and shelters. A 70 85% write-off of the initial investment is typical. This is a powerful reason for buying in.
They also know that because potential returns are greater, the risks may be higher than with stocks. So they are willing to allocate a portion of their assets to oil and gas limited partnerships. How much? It is their decision. If they have a lower tolerance for risk, they put in a smaller portion, and conversely for a higher risk tolerance.
And finally, they understand the benefits of building over time a portfolio of oil and gas partnerships. Just like with a mutual fund, building a portfolio means diversification, which reduces your risk while giving a higher return. So it seems like many accredited investors should be interested in limited partnerships.
It is unfortunate that the oil and gas industry has not done a better job educating investors. That is precisely what our website is doing for you right now, so please read on
Mlp #: Plains All American Pipeline Lp
- 5-year expected annual returns: 16.2%
Plains All American Pipeline is a midstream energy infrastructure provider. The company owns an extensive network of pipeline transportation, terminals, storage, and gathering assets in key crude oil and natural gas liquids producing basins at major market hubs in the United States and Canada.
On average, it handles more than 7 million barrels per day of crude oil and NGL through 18,370 miles of active pipelines and gathering systems. Plains All American generates around $40 billion in annual revenues and is based in Houston, Texas.
Source: Investor Presentation
On April 6th, 2022, Plains All American hiked its distribution by 21% to a quarterly rate of $0.2175.
On November 2nd, 2022, Plains All American reported its Q3 results for the period ending September 30th, 2022. Revenues came in at $14.3 billion, an increase of 32.4% year-over-year. The significant increase compared to last year was driven by global crude oil demand following its post-pandemic recovery. Higher global oil prices were also a positive contributor. Finally, increased production in the Permian Basin significantly boosted results, ending the quarter at roughly 5.7 million barrels a day, compared to 4.4 million barrels in the prior-year period.
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