BRAD UPDIKE, MICK LAW PC, OMAHA, NEB.
A REVIEW OF POPULAR DRILLING PROGRAM INVESTMENTS AND EMERGING PRODUCT STRUCTURES
Non-traded energy opportunities
HOW FAR we have come in two years?
W TI oil prices in the summer of 2014 averaged about $100 per barrel with Brent oil
pricing pushing $110/bbl. Through 2015
and much of 2016, however, we have witnessed oil prices fluctuate from $26 to $50/
bbl. While price patterns in late spring 2015
gave the energy industry a glimmer of hope,
the series of announcements by OPEC to
keep its production target at historic high
levels has cast doubt as to when we might
ever see oil price patterns that are closer
to the levels observed from 2010 through
On top of the challenges in the oil markets, natural gas operators have not fared
much better, with gas prices fluctuating at
levels of about $1.75 to $2.50 per mcf
through much of this year. Such is the challenge of those dependent upon drilling to
make their businesses profitable.
Historically, tax-advantaged drilling programs have dominated the non-traded
energy investment arena. While drilling in
certain US basins today may work on a
pure field-level basis (with the Permian
Basin presenting better economic opportunities), break-even capex points for retail
syndicated drilling partnership programs
(“drilling programs”) trend about 25% higher than the field-level capex based on offering costs and program manager
Certain proactive drilling program sponsors are addressing pricing challenges by
applying improved completion technologies to old fields where oil and natural gas
resources were established years ago. Even
with better completion strategies and income tax deductions that generate tax
savings of 40% to 45% of an investment,
many drilling programs will be hard pressed
to make their programs model at adequate
returns under current pricing conditions.
In spite of energy prices, trends devel-
oping within the non-traded retail-syndi-
cated energy product space are focused
upon capturing acquisition-driven upside that might not have existed at higher commodity
prices. We’ll begin with a review of what’s happening with historically popular drilling
program investments and then follow with a discussion of some emerging retail product
structures positioned to take advantage of today’s commodity prices.
Despite a growing number of programs with acquisition-based strategies, there continues
to be an appetite among high net worth investors for programs that are designed to provide
high income tax deductions through drilling. These programs are structured as limited
partnerships and are marketed to retail investors through private placements.
Drilling programs are designed to provide investments whereby 65% to 85% of the
investor’s capital will be deductible in the first couple years of the investment through
special allocations of IDCs to investors. For high tax bracket investors in states with high
income tax rates, the IDC deduction can potentially translate into a tax deduction equal
to 35% to 40% of the investment.
In addition to getting the allocation of IDCs, investors can determine the active or
passive character of their IDCs by electing to participate in the program as a limited partner
or as a general partner. For investors who participate as general partners, they can deduct
IDCs and other drilling costs against active income such as wages and income from
managed businesses. Investors participating as limited partners must deduct IDCs and
other related deductions against passive income such as income from most real estate
investments and income from businesses not actively managed.
Drilling partnerships also seek to provide investors with long-term cash flow from oil
and gas production revenues. Historically, the geographic coverage of these programs
spanned across plays that included the Appalachian Basin, Rockies, Anadarko Basin, East
and West Texas, and the Louisiana/Texas Gulf Coast. However, in view of lower oil and