Myths Of Investing In Oil Wells

MYTH #1 – YOU CAN LOSE ALL OF YOUR MONEY.

The Truth –If a well is productive or non-productive the cost of that well is an “expense” and may be deducted from other sources of income on your federal taxes. These expenses are known as intangible drilling costs (IDC’s). Since a significant portion of dollars at risk would have been paid in taxes anyway your actual dollar risk exposure is reduced by your tax bracket. The Federal Tax Code makes investments in oil and gas ventures one of the best tax advantaged investments.

 “Intangible Drilling Cost Tax Deduction (IDC)” allows you to write off 100% of the cost for drilling a well. These costs include, drilling rig, location, chemicals, fuel, mud, labor, survey, transportation, cementing, etc., which make up approximately 50% to 75% of the total well cost. It is important to note that IDC is a 100% write off regardless of the outcome of the well, dry hole, or producer. The Investor may also elect to amortize the IDC over a five-year period.

Tangible Drilling Cost Tax Deduction

The total amount of the investment allocated to the completion of the well such as tubing and production equipment “Tangible Drilling Costs (TDC)” is 100% tax deductible as depreciation over a seven-year period.

Active vs. Passive Income

The Tax Reform Act of 1986 introduced into the Tax Code the concepts of “Passive” income and “Active” income. The Act prohibits the offsetting of losses from Passive activities against income from Active businesses. The Tax Code specifically states that a Working Interest in an oil and gas well in not a “Passive” Activity, therefore, deductions can offset against income from active stock trades, business income, salaries, etc.

Percentage Depletion Allowance Tax Deduction for Small Companies and Individuals.

The 1990 Tax Act provided special tax advantages for small companies and individuals. This tax incentive, known as the “Percentage Depletion Allowance”, is specifically intended to encourage participation in oil and gas drilling programs. Large oil companies do not benefit from the Depletion Allowance due to large production rates, over 1,000 BOPD or 6,000,000 cubic feet of gas. The “Small Producers Exemption” allows 15% of the Gross Income (not Net income) from an oil and gas producing property to be tax-free.

Therefore, you see it is true. Congress has provided tax incentives designed to stimulate domestic oil and gas drilling and in theory help pay for drilling your well. In essence, you could never lose all your money because it never was all your money in the first place. The government was going to get their part of your income regardless of whether you invested in an oil well or not. In fact, they were going to get between 25% to 37% of your income anyway.

There are more incentives concerning oil and gas leases and tax rules concerning the Alternative Minimum Tax. Remember, Kitty Hawk advises that you should check with your financial consultant before making an investment.

MYTH #2 – IT IS MORE PROFITABLE TO BUY STOCK IN EXXON OR A MAJOR OIL COMPANY FROM MY STOCKBROKER THAN TO INVEST IN AN OIL WELL.

The Truth – When you purchase stock from a stockbroker or online in essence you are buying tiny piece of a huge corporation with millions of many different pieces. There is some comfort in knowing that it is a large corporation with holdings all over the world, but it also comes with a huge overhead to support. When one purchases stock in such a large corporation with their large overhead it takes a lot of movement in the market for one to make a substantial profit, plus you are buying the stock with “post” tax dollars so you only getting to invest 60% to 75% of the income you had earned. You have already given up a large part of your buying power before you even start. When you invest into an oil well it is called “Direct Participation” and that is what is happening. You are investing directly either in the traditional one oil well plan or a group of oil wells, such as the K*FUND Drilling Program. Your investment is more focused on the production of oil and not on the running of a huge corporation. Your investment will have the chance to grow faster and larger when it is prudently focused instead of invested in a huge corporation where it is used to run the machine.

MYTH # 3 – MOST OIL WELLS ARE A DRY HOLE. THEY ONLY FIND OIL IN ABOUT 1 OUT 10 WELLS DRILLED.

The Truth – There are different kinds of drilling when it comes to finding oil. The type that most people have heard of is “Wildcatting”. It is what was talked about on the TV movies and shows of “Giant” and “Dallas” where the guy goes out into the middle of nowhere. He is down and out on his last dollar when he hits a gusher and it blows out shooting oil everywhere and everyone lives happily ever after like Jed and the “Clampetts”. Drilling in the middle of no known oil production makes your odds of getting a dry hole very high, probably more like 90 to 1 that you will be successful.

The other type of drilling that is done with a much higher success rate is “Drilling Inside or Close In”. In this type of drilling, you are drilling next to or very near existing production in known oil fields. This type of drilling is successful and generally has a much higher success rate. Before investing know your well, wildcat or Close In, it will greatly enhance your success.

MYTH # 4 – IF SOMEONE OFFERS YOU AN OPPORTUNITY TO INVEST INTO AN OIL WELL IT IS A SCAM.

The Truth – The best way to find out if you are getting a good investment opportunity is to do the research. Generally, that is why people buy stocks and investments from a stockbroker or online service, because they may not have the time to do the research and therefore rely on an expert. An investment representative will ask them their tolerance for risk and then invest accordingly.

When investing in an oil well do the research. Companies like Kitty Hawk Energy will invite you to their offices to outline their drilling program. You should be able to hear what the geologist, geophysicist, and engineer have to say about the wells to be drilled. Successful oil companies are willing to educate the investor who wants to learn more about the process of drilling and producing wells. They welcome questions and comments. As an investor you should always be able to communicate with the people who are making the decisions. Knowledge is power. If you want to increase your chances for success and reduce your risk, ask questions, and learn.

MYTH #5 – I KNOW THAT THE ONLY REASON I AM ASKED TO INVEST INTO AN OIL WELL IS BECAUSE THEY KNOW IT ISN’T GOING TO BE A GOOD WELL.

The Truth – If anyone really knew the outcome of a well before it was drilled do you think they would be asking you to invest? No one knows for sure but through rigorous study the geoscientists have a solid, realistic idea based on facts, institutional knowledge, and intuition. Remember we are not drilling a sure thing every time; Mother Nature can throw a knuckleball occasionally. That’s why we employ the “Kitty Hawk Edge” to mitigate risk for the K*Partners. It’s always good to note when drilling any prospect, the results are unknown, but we bring to bear Kitty Hawk’s team with its arsenal or knowledge and expertise to ensure success.

Wells are different.  Wells right next to each other can have different results. That is why oil operators share the wealth and the risk when drilling. Even the largest companies in the world like Exxon, Total, Shell, or BP share the risk when they are drilling new projects, because they too know that there are risk factors that need to be managed. Remember, it is better to have smaller interest in multiple wells than have a large interest in one well.

MYTH #6 – INVESTING INTO AN OIL WELL IS EASY, BUT IT IS AFTER THEY START THE WELL IS WHEN IT GETS EXPENSIVE.

The Truth – With rare exception, are the costs associated with operating and producing a well more than the cost to prepare, drill and complete the well. Well workovers do occur periodically but are necessary to keep production rates economic. Since Kitty Hawk has their money invested right along with the “K*Partners” their economic incentives are aligned. Keeping lease operating expenses (LOE) low is always of main concern for the operator. Reducing costs for rental equipment, chemicals, labor, insurance, and administrative overhead, to name a few, are very important. Good operators have standing policies. They take several bids for well work to insure competitive pricing. However, knowing the contractor or service provider is paramount in reducing costs and ensuring quality.

MYTH #7 – DRILLING OIL WELLS SOUND DANGEROUS AND COULD HAVE A LOT OF LIABILITY AND I DON’T WANT TO BECOME PART OF THE LIABILITY FACTOR.

The Truth – Investing into oil wells is like when you buy stock. You are only liable for your investment. In the stock market if the company you invested in goes broke or has a product liability issue you are not affected by these issues other than your investment may go down or become worthless. The same is true when investing in an oil well where you have an operating agreement between yourself and the operator stating the responsibility and liability. It is like getting the best of both worlds. You are on the ground so to speak in the front row watching your investment, but without any of the liability.

MYTH # 8 – OIL WELLS DON’T HAVE A VERY LONG-LIFE SPAN.

The Truth – Oil wells generally have a long-life span. Obviously initial production rates are higher. Wells deplete. Again, it’s the “Edge” at work, drilling wells with multiple objectives. Each virgin sand is like a new well with initial higher pressures and more robust production. Wells do deplete over time as the drive mechanism in the reservoir reduces. Some oil wells may need help later in life. Secondary recovery such a pumping or using gas lift can extend the productive life of a well. Inherently the type of wells the “K-Partners” will be investing in will have extended lives. The production rate won’t always be at the initial high daily rate in the original completion, but with prudent management and attention to detail, our wells should last many years.

MYTH # 9 – IF THE PRICE OF OIL GOES DOWN AND THE WELL IS A LOW PRODUCER, I WON’T EVER GET MY MONEY BACK.

The Truth – Everything in life is cyclical. Things go up and things go down. The price of oil is no different. We are dealing with a highly traded commodity. We have seen today’s “New World" marketplace provide stability. The cycles in commodity price are more frequent therefore this effect provides stability. There are 1.4 Billion people in India with a middle class as large as the whole population of America. China is even larger. They are consuming more and more energy daily with no end in sight. Our timing is optimal for higher energy prices as Saudi Arabia and Russia hold the line on production quotients while their countries grow and prosper. Unlike the larger independents or integrated oil companies “K*Partners” is agile. We can choke back production dictated by market price and hold off on certain drilling or well workovers until the market adjusts.  

MYTH # 10 – IF I INVEST IN AN OIL WELL, I WILL BE STUCK WITH IT FOREVER AND WON’T BE ABLE TO SELL MY INTEREST.

The Truth– An interest in an oil well is sellable because it is based on cash flow. Just like a stock is priced based on earnings times a multiple an oil interest is the same way. The longer you own an oil interest and the more established the production becomes the easier it is to sell because it has a proven cash flow record just like a stock chart of a company.

MYTH # 11 – ALL THE OIL has BEen FOUND SO WHY WASTE money and effort DRILLing?

The Truth – It is believed that all the big oil, or easy oil, has been found in the Continental United States. Resource oil plays are ‘en vogue’ but let’s not fool ourselves. Several important truisms exist: 1) Tremendous opportunities remain in conventional oil, 2) Oil is the transition fuel of this century and I dare say for quite some time thereafter, 3) There are thousands of proven oil fields in the United States with oil reserves in place that have yet to be discovered and exploited and 4) There are hundreds upon hundreds of prospects to be drilled in the pent-up hands of independent oil finders.

With the continuing advancements in technology, such as well logging, completion techniques and fracking, fields that were once dormant are coming to life again. At today’s prices, low risk drilling, in and around existing oil fields can be very profitable and cost effective. Given today’s market, Louisiana ranks as one of the top producing states in Lower 48. “K*Partners” wants to be part of America’s energy independence. Kitty Hawk hopes you will be part of that independence.

* Please see SEC web site ia_oilgas.pdf (sec.gov), the Office of Investor Education and Advocacy for information on PRIVATE OIL & GAS OFFERINGS.