The International Energy Agency (IEA) reported in 2018 that the United States became the world’s largest producer of oil, surpassing that of rival oil producers Saudi Arabia and Russia. Additionally, the United States also became a net exporter of oil in 2018, a distinction not held in 75 years. With US production ramping up and global demand continuing to rise, the US will soon become the world’s largest exporter of oil and supplier of global energy.
US daily oil exports currently at 3.6 million barrels per day is expected to nearly triple to 9 million barrels a day by 2024.
During this period global demand is expected to witness significant increase primarily fueled by emerging and developing economies rapid technology-driven growth with the risk of global energy demand exceeding global output unless action is taking now.
The United States is forecast to provide 70 percent of the rise in global oil production and 75 percent of the rise in natural gas by 2024. This dramatic shift in supply growth will witness financial windfalls for US producers and their partners which will exceed that witnessed by the middle east in the 1970s and will have profound and dramatic implications for the geopolitics of energy.
The transportation sector will remain the largest consumer of oil while global population powerhouses China and India will witness automobile ownership rise from a combined 200 million cars to over 735 million cars in the decade ahead.
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In recent weeks, Exxon Mobile, British Petroleum and Chevron Phillips all announced a significant increase in production in their efforts to meet future global demand. In 2018, IEA warned of global shortfalls unless producers invest now to meet demand.
The International Energy Agency (IEA) announced last week that they expect global oil demand will rise by 1.4 million barrels per day in 2019. Global oil demand Q4 2018 rose by 1.4 MB/day year-on-year setting up 2019 for the continued global rise in demand.
Most of the expected rise in 2019 demand will be from the United States, China and India which together account for 1.19 MB/day of the 1.4 MB/day 2019 forecast rise.
Global supply declined in January 2019 by 1.4 MB/day partially due to Venezuela’s supply cuts and sanctions. World wide oil prices rose in January 2019 with prices expected to continue to rise as the northern hemisphere moves into the high demand season the spring and summer.
Crude oil quality is another issue affecting the markets, particularly those with the supply of heavy, sour oil, which is used for diluents and blending. Venezuela typically produces heavy oil and global prices are expected to witness further rise while heavy oil supply declines. At the moment, no indication the Saudi’s will raise production to meet this shortfall. Overall, demand will remain firm for 2019 with the US and its producers leading the way to meet this continued rise in global demand.
Investors’ participation in oil and gas partnerships has reached a multi-year high in 2018 primarily due to a sustained rise in prices, but also due to capitalizing on large deductions in the year of the investment. Considered one of the top tax-advantaged investments, oil and gas partnerships not only offer large deductions but also provide the opportunity to receive tax-advantaged investment income.
However, the investment has to be made by December 31st for the investor to receive the tax benefit in the year of investment. The investor should consult their tax advisor to determine their tax liability for the current year and the characterization of the income that caused the liability: passive or non-passive income. Investors should consider their risk tolerance for such a tax-advantaged and illiquid investments though with deductions up to 100% of their investment, investors can easily offset the risk thru tax savings.
Lawmakers in our effort to achieve energy independence added to the Internal Revenue Code incentives to make drilling for oil and gas a very favorable taxable event with such an investment very tax-favored – intangible drilling costs, a functional allocation exception to the passive loss rules, alternative minimum tax, and the depletion allowance leading the way.
Intangible Drilling Cost
When wells are drilled, the costs associated with the drilling are pided into two types: tangible and intangible. Tangible costs are defined as a salvageable part of the drilling costs and are depreciated over seven years. Intangible costs are the remainder of the costs incurred to drill and complete a well. Such costs include, but are not limited to: labor, chemicals, grease, fuel, supplies, and other necessary costs for drilling a well and preparing it for production. Based upon the drilling program, the intangible drilling cost may range from 70-85% of the total cost to drill and complete a well.
The amount of tangible and intangible drilling costs allocated to investors is based upon each drilling program. In some programs, the investor may receive 100% of the intangible drilling costs and no tangible costs. In other programs, the investor may receive 80-90% of the IDC’s and an allocation of the tangible drilling costs. The drilling programs do this based upon partnership accounting that allows a disproportionate allocation of revenue and expenses between partners. The Internal Revenue Code requires the allocation to withstand an economic viability test that requires a value to be traded for equal value.
Deductibility of Intangible Drilling Cost
When the investor decides which drilling program to invest in, he receives an allocation of IDC’s – for example 80, 90, or 100%. At this point the investor has options as to when to deduct the IDC’s. An investor may deduct 100% of the allocated IDC’s in the year of investment. Or, the investor may choose to amortize the deduction over 60 months, or may elect to deduct part of the IDC’s in the year of investment and capitalize and deduct the remaining IDC’s over a 60 month period. As you can see, there is great flexibility for the investor.
The drilling partner’s obligation is to start, or spud, all the wells within 90 days following the end of the year of investment.
This makes the IDC’s deductible in the year of investment. At this stage we have touched on intangible drilling costs, functional allocation, and timing of the deduction.
A quick example may help: cost to drill and complete a well, $1,000,000. Amount of cost that are intangible: 85%. Total intangible drilling cost: $850,000. IDC’s allocated to investors: 100%. Total IDC’s allocated to investors: $850,000.
Exception to Passive Loss Rules
An investment in a drilling partnership would typically be in the form of a limited partnership. This would be considered passive activity in that the investor does not materially participate in the operations in a substantial manner. Accordingly, this investment would only be deductible against passive income. However, there is a major exception to the passive loss rules. By holding an oil and gas working interest in an entity that does not limit liability (general partner) during the drilling and completion phases, the investor may take the IDC deduction against non-passive income (earned or portfolio income). This exception to the passive law rules opens up huge opportunities to reduce non-passive taxable income.
In most programs investors who elect to be a general partner are converted to a limited partner when all the wells have been completed, as determined by being placed into production. However, if the investor has passive income they can elect limited partner status and receive the benefit of the IDC deduction against their passive income. Hence, you can have your cake and eat it, too!
Alternative Minimum Tax
One of the major questions I receive is how AMT figures into the IDC deduction. By regulation, IDC deductions are not tax-preference items. However, if an investor reduces Alternative Minimum Taxable Income (AMTI) by more than 40%, AMT will be triggered. If the investor elects to amortize their IDC deduction over 5 years, none of this will be considered excess IDC’s. When an investment is made in a drilling partnership the investor must monitor his AMTI. The 2018 Tax Cuts and Jobs Act did make some changes with the AMT exemption and threshold amounts.
When the wells the investor owns begin profitably producing, the investor will receive income from the wells. This income will be partially sheltered with a depletion allowance. The current depletion percentage is 15%. Accordingly, for each $1,000 an investor receives, $150 would be tax-free.
Invest in Oil and Gas Partnerships
As you can see, an investment in an oil and gas drilling partnership is a very tax-advantaged investment. Additionally, with global production nearing peak levels while global demand continues to rise, its a mathematical certainty that unless production output dramatically increases, the world will soon witness a global oil shortfall with prices reaching levels not seen since 2008 when oil reached $147 per barrel. The tax benefits generated by a direct participation in oil and/or natural gas are substantial.
The immediate deduction of the intangible drilling costs or IDCs is very significant, and by taking this up front deduction, the risk capital is effectively subsidized by the government by reducing the participant’s federal, and possibly state income tax. Each inpidual participant of course, should consult with their tax advisor.
DISCLAIMER: Viper Capital Partners LLC, is not a Tax Advisor, CPA, or Tax Attorney and is not certified to give any tax advice. The information on this page is for educational purposes only. Inpiduals should consult their own tax professional for advice. Viper Capital Partners LLC offers no professional tax advice.
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Crude oil setting up for upside breakout of huge multi-year consolidation pattern which dates back to 2003. Similar but smaller patterns occurred in 2011 which resulted in the 2014 downside break and subsequent decline in prices of $79, reaching a low of $25.75 in 2016 and again an even smaller pattern in 2017 which witnessed the 2018 upside break and $36 rally to 77.06, just a few cents above the 76.63 target I called for in my 2018 forecast.
These patterns always occur after a trending market and always proceed a breakout.
There is a very reliable and direct correlation between the duration of the consolidation pattern and the length and momentum of the subsequent breakout.
For example, the 2011-2014 pattern resulted in a breakout price move of $79, whereas the 2016-2017 much smaller pattern resulted in a modest $36 price move.
I have been trading these patterns with 100% accuracy for almost 30 years and formulated very specific mathematical calculations and rules to accurately forecast the timing of these breakouts along with their all-important price targets. For example, Spot Gold and the British Pound were both in a similar patterns back in 2011 and my analysis at that time https://www.fxlivetrader.com/forecast-for-2011-eurusd-gbpusd-spot-gold/ accurately predicted gold to rally from $680 to $1,904. The actual high was $1,920, just $16 higher than the price target I predicted months earlier.
Crude oil is in the final stages of a 20-year developing pattern that will witness an explosive and dramatic price move supported by high volume futures trading and global oil demand. And unlike the dramatic rise and fall in oil prices witnessed in 2008, this go around will witness a steady and sustained rise in prices fueled by emerging market demand to grow their rapidly developing and advancing economies. As a result of this unprecedented demand, oil producers worldwide will not be able to keep up with demand as recovery, refinery and delivery capabilities will all reach maximum utilization. Oil prices will steadily rise as oil will remain the dominant energy source well into 2050.
As to price targets, please take a minute to watch my short 15-minute video at the link below.
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Crude Oil 2019 Outlook
Crude Oil Set to Breakout of 20 Year Pattern