Oil and Gas Investments
Questa Energy Corporation is continually developing oil and gas projects primarily in the Mid- Continent region. Questa retains a substantial equity position in most projects, and the remaining interests are offered to knowledgeable investors and industry participants. A typical project is developed by securing acreage based on specific geologic conditions. A prospectus can be created once the acreage is secured. The prospectus may include a geologic, land, and engineering summary, geologic and land maps, an estimate of costs in the form of an Authority for Expenditure (AFE), a participation agreement and joint operating agreement (JOA).
Exploration efforts are concentrated in niche areas where we can utilize our local knowledge and expertise. We have been prinapally involved in both horizontal and vertical drilling projects located in Texas, Oklahoma, and Kansas. Adequate data is required to be able to analyze prospective acreage for a potential drilling location and to insure a quality reservoir capable of producing substantial quantities of oil and gas. Projects target long life reserves (15-20 years+) and quick pay-outs (36 months or less) and rates of return are expected to be no less than 20%.
Oil and Gas Tax Benefits
Direct participation in oil and gas can generate several tax benefits. These benefits range from large up front deductions for intangible drilling costs (IDC), to tax credits for the development of certain types of tight formations. Deductions are generated mainly from the cost of nonsalvageable equipment or services conducted during the drilling phase, testing, and/or completion of the well.
Direct participation in oil and gas is for the risk tolerant investor. Oil and gas investment provides an inflation hedge, as well as diversity to an equity investment portfolio.
The following is a synopsis of the tax benefits generated by direct participation of oil and gas investments:
Intangible Drilling Costs (IDC)
When an oil or gas well is drilled, several expenses may be deducted immediately. These expenses are deductible because they offer no salvage value whether or not the well is subsequently declared to be dry. Examples of these types of expenses would be labor, drilling rig time, drilling fluids etc. IDCs usually represent 60% to 80% of the well cost. Investors usually put up the drilling portion of their investment before drilling operations commence, and the investor's portion of the intangible drilling costs is generally taken as a deduction in the tax year in which the intangible costs occurred. The accounting method adopted however could affect the deduction period.
Intangible Completion Costs
As with IDCs these costs are generally related to nonsalvageable completion costs, such as labor, completion materials, completion rig time, fluids etc. Intangible completion costs are also generally deductible in the year they occur, and usually amount to about 15% of the total.
As opposed to services and materials that offer no salvage value, equipment used in the completion and production of a well is generally salvageable. Items such as these are usually depreciated over a seven year period, utilizing the Modified Accelerated Cost Recovery system or MACRS. Equipment in this category would include casing, tanks, well head and tree, pumping units etc. Equipment and tangible completion expenses generally account for 25 to 40% of the total well cost.
Once a well is in production, the participants in the well are allowed to shelter some of the gross income derived from the sale of the oil and/or gas through a depletion deduction. Two types of depletion are available, cost and statutory (also referred to as percentage depletion). Cost depletion is calculated based upon the relationship between current production as a percentage of total recoverable reserves. Statutory or percentage depletion is subject to several qualifications and limitations. This deduction will generally shelter 15 per cent of the well's annual production from income tax. For "stripper production" (wells producing 15 barrels/day or less), the depletion percentage can be up to 20%.
Congress has enacted several tax credits in relation to oil or natural gas production. The enhanced oil recovery credit is applied to certain project costs incurred to enhance a well's oil or natural gas production. This credit is up to 15% of the costs incurred to enhance production. The non-conventional source fuel credit provides for a $3 per barrel of oil equivalent credit for production from the so called qualified fuels. Qualified fuels include oil shale, tight formation gas, and certain synthetic fuels produced from coal.
Lease Operating Expense
This expense covers the day to day costs involved with the operation of a well. The expense also covers the costs of re-entry or re-work of an existing producing well. Lease operating expenses are generally deductible in the year incurred, without any AMT consequences.