Top 12 Oil and Gas Investing Terms to Know
Having a basic understanding of oil and gas investing concepts before you start investing in oil and gas wells is important to succeed as an investor. Here are twelve terms you should know before investing in oil and gas assets.
January 3, 2024
1. Working Interest
Working Interest ownership in oil and natural gas wells is comparable to owning tangible property, much like real estate. Working interest owners not only share in a well’s revenues but also shoulder responsibility for a well’s costs. Unlike owning equity in an oil and gas company, property-based ownership safeguards passive investors from the risk of bankruptcy. If an energy operating company goes bankrupt, the non-operated working interest, or working interest held by passive investors, remains intact ensuring passive investors retain their ownership interest.
2. Royalty Interest
Royalty Interest in oil and natural gas wells provides a direct share in the revenues without the corresponding responsibility for operational costs. While royalty interest in oil and natural gas wells does offer a lower-risk profile compared to Working Interest ownership, it's essential to note that this reduced risk exposure comes at the expense of a lower expected internal rate of return for investors. This reduced financial commitment and risk mitigation make royalty interests an option worth considering for those seeking a more conservative investment strategy in the oil and gas industry, acknowledging the trade-off between lower risk and potentially lower returns compared to Working Interest ownership.
3. Proved, Developed, and Producing ("PDP")
Proved, Developed, and Producing ("PDP") is an oil and gas well classification which indicates that oil and gas reserves are actively being produced by a given well. In contrast to PDNP and PUD wells that are not currently in production, investing in PDP wells, with their proven production, is a less risky venture, offering more predictable expected returns. In contrast, PDNP wells (wells that have been drilled but are not currently producing) and PUD wells (planned wells that have not been drilled and have no proven history) offer a more volatile expected return profile.
4. Unconventional Wellbores
Unconventional wellbores utilize a combination of hydraulic fracturing and horizontal drilling technologies to extract oil and gas from reservoirs with low permeability. Due to the low permeability characteristics of these wells, the interaction between wells is constrained which makes them excellent candidates to package into diversified pools of investable assets which lowers an investment’s effective expected production volume volatility.
5. Conventional Wellbores
Conventional wellbores use traditional drilling methods to extract oil and gas from easily accessible reservoirs. Multiple conventional wells share a common reservoir, resulting in interdependence where the production from one well significantly influences others.
6. Discount Rate
The discount rate is a critical factor in evaluating the economic feasibility of investments by determining the present value of future cash flows. This concept, which considers the time value of money, acknowledges that money today holds more value than the same amount in the future. By assessing the present value of anticipated cash flows, investors can gauge the attractiveness of investments, factoring in the inherent risks and uncertainties associated with the industry. The discount rate for oil and gas investments is not one-size-fits-all and should be tailored to the specific characteristics and risks associated with each project. Adjustments consider factors such as the nature of the reserves, geopolitical stability, market conditions, asset quality, and the financial structure of the investment.
7. Parent-Child Well Interactions
Parent-Child Well Interactions describe the phenomenon wherein the drilling and completion of one unconventional well impacts production from nearby horizontal wells. Managing these interactions is essential for maximizing overall production performance. A common strategy for oil and gas companies to minimize the harmful effects is shutting in the parent wellbore. This strategy plays a pivotal role in optimizing reservoir behavior and ensuring safe and efficient extraction from the entire well network.
Upstream activities in the oil and gas industry involve the exploration and production of crude oil and natural gas. This phase encompasses everything from locating potential reserves to extracting hydrocarbons from the earth.
Midstream activities involve the transportation, storage, and wholesale marketing of oil and gas products. This sector ensures the efficient and reliable movement of hydrocarbons from the production site to refineries and end consumers.
Downstream activities involve the refining, distribution, and marketing of oil and gas products. This sector focuses on converting crude oil into usable products and delivering them to end consumers.
11. Depletion Tax Deduction
This is a tax deduction for the owners of producing wellbore interests. The depletion allowance is a means for investors to account for the depletion of their reserves during the production and sale of oil and gas. It is a deduction from gross income and is a reflection of mineral deposit reductions.
12. Intangible Drilling Costs tax deduction
Intangible Drilling Costs are expenses related to the drilling and completion of oil and gas wells where the aforementioned costs have no salvage value. These intangible costs are tax deductible. As a result, this makes 60% - 80% of total drilling costs tax deductible. Oil and gas investments utilizing IDC tax deductions often come with increased risk. The assets benefiting from these deductions may lack proven historical production, amplifying uncertainties associated with the success and profitability of the drilling venture.
By familiarizing yourself with these key terms, you'll gain a comprehensive understanding of important oil and gas concepts central to oil and gas investing. For insights into oil and gas investing and the potential benefits of direct investments in oil and natural gas wells, visit our website: energia.com.
Q1. What makes Working Interest in Oil Wells a unique investment?
A1. Working Interest in oil wells allows investors to own a direct stake in production and revenues, a significant aspect of oil and gas investments.
Q2. How do Royalty Interests in Natural Gas differ from other investments?
A2. Royalty Interests in natural gas provide a passive investment option in the natural gas market, offering earnings without the burden of operational costs.
Q3. Why are Proved Developed Producing Wells considered a safer investment?
A3. PDP wells are considered safer due to their established production, offering predictable returns in the oil stocks market.
Q4. What are the advantages of investing in Unconventional Wellbores?
A4. Investing in Unconventional Wellbores can access resources in low permeability areas, offering new opportunities in energy sector trends.
Q5. How does Downstream Oil and Gas Refining impact the industry?
A5. Downstream oil and gas refining plays a crucial role in transforming crude oil into marketable products, affecting the overall profitability of oil and gas investments.
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