Mosburg 3-7-99-2b

THE WHYS AND HOWS OF OIL AND GAS INVESTMENT IN THE NEW MILLENIUM

Chapter One: The "Basics" of Oil & Gas Investment

By Lewis G. Mosburg, Jr.
Copyright 1986, 1999 by Lewis G. Mosburg, Jr. All Rights Reserved.

Part One: The Purpose of Oil & Gas Investment

Traditionally – and understandably – investing oil and gas has been labeled a "tax-shelter." Without question, the tax advantages of oil and gas drilling are one of oil's key attractions, and a significant factor in analyzing the economic potential of oil and gas investment. However, far too many "tax-sheltered" investors have forgotten, often to their sorrow, an economic "basic:" the purpose of investing is to make money!

If the objective of investing in oil were simply to reduce your taxes, there is a far easier way: just give your money to charity. An investment program that drills all non-productive wells ("dry holes") will certainly reduce your taxes, irrespective of the "tax reform" of the last two decades. And one way of analyzing the results of such a "wipeout" investment is to remember that Uncle Sam bore half the loss.

But the other – and more realistic – way of analyzing this dry hole adventure is to realize that your "hard dollar" investment – the portion of your participation that was not offset by tax savings – was lost by you. And losing fifty cents on the dollar of your own money just to spite the government doesn't seem like much of an "investment."

Despite drilling's reputation as a "go for broke" activity, most oil and gas investments won't result in a total loss of the dollars invested. Certainly, "experimenting" with oil and gas participation by putting all of your money in a single well can lead to such a result.¹ And even investing in a series of wells could lead to a loss of your entire investment if high-risk exploratory "wildcats" were involved.² However, an equally important consideration, and one which many investors fail to understand, is this:

If your return from productive wells is substandard – if you never recover your original investment, or recover that investment too slowly – you still haven't realized a reasonable return from participating in the oil and gas search!

You may have heard that, with drilling's admitted tax advantages, you are "making money in oil" if you simply recover one dollar of oil and gas production revenues for each dollar you have invested. And you are receiving a "return" of a sort – about the same level of return that you could have realized from a savings account! (And that's after giving consideration to the tax advantages!)³

That's not to say that oil and gas drilling doesn't have significant tax advantages, which are critical to realizing a reasonable return from this type of investment. We'll have a lot to say about this in later articles in this series. What we are saying is that all the tax advantages in the world won't turn a mediocre oil and gas proposal into an after-tax bonanza.

So your oil and gas investment strategy has to be aimed at making money, and not merely reducing your taxes. But the good news: intelligent oil and gas investment can accomplish both!

Coming Next: "The Benefits of Oil and Gas Investment"

¹Yes, there are "sure thing" areas in which virtually every well is productive. However, the other "sure thing" about investing in such wells is that the wells rarely prove economically rewarding, even to those investors in the higher income tax brackets. (If the well is such a "sure thing," why do you think the oilman is willing to let you participate?)

²The role of diversification in offsetting dry-hole risk will be discussed in a later article in this series.

³We'll have more to say about return in our later articles dealing with "Measuring Oil and Gas Investment Economics."

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