Posted on Jul 20, 2017

Oil and gas investments have unique aspects of finance and taxes that are not seen in any other industry. High oil inventories have driven commodity prices and oil investment prices down, and it may be time to consider adding oil investments to a portfolio. Different entity structures and the accounting methods used make it difficult for investors to get a side-by-side comparison of O&G developers. Investors need to understand the pros and cons of each investment type under consideration, including the impact of accounting methods used, the developer’s strategy with regard to reserves, and finally the potential tax benefits or impacts.

‘Rise early, work late, strike oil.”

This quote was attributed to J. Paul Getty, one of the first U.S. oil tycoons who was once listed as the world’s richest private citizen at $1.2 billion. That was in 1966.

Anyone with dreams of striking it rich through oil and gas investments needs to rise early and work late to choose the right investment option. Investor responsibilities and tax compliance are complex. If it seems like a good way to diversify an already well-rounded portfolio, however, the landscape for investment is certainly looking up.

Over the last decade the U.S. oil and gas industry has undergone somewhat of a renaissance due to technological improvements in hydraulic fracturing, horizontal drilling, drilling fluids, and other techniques, which has allowed U.S. producers to begin to economically unlock the shale oil reserves. The result has been increasing U.S. oil production for the first time since 1970 when U.S. oil production peaked at nearly 9.7 million barrels of oil per day. By 2008, U.S. oil production had fallen to approximately 5 million barrels of oil per day.  Currently, U.S. production is on pace to exceed 9.9 million barrels of oil per day by 2018, an increase of nearly 100% in 10 years.

With the resurgence of the U.S. oil and gas industry, investment opportunities abound. I am a tax compliance expert, so this information should not be interpreted as investment advice. This article will briefly touch on the various types of oil and gas investments available today and will discuss the unique accounting and tax attributes related to these types of investments.

Types of Oil & Gas Investment

The following is a brief summary of different types of oil and gas investments. The bullet points outline the pros and cons for investors.

Publicly traded stocks (such as the major integrated oil companies and large independent oil companies) and ETF’s:

  • Highly liquid since there is an active trading market
  • Income and expenses are not passed through to investors.
  • Company retains any beneficial tax attributes
  • Cash returned to investors via dividends or stock buy backs
  • Arguably, the primary goal is increasing value through increasing reserves and production

Master Limited Partnerships (also publicly traded)

  • Highly liquid since there is an active trading market
  • Income and expenses are passed through to investors, thus investors are taxed on the operating income of the company
  • Beneficial tax attributes such as depletion and drilling costs are minimized because of publicly traded partnership/passive activity tax rules
  • Cash flow is normally distributed to partners on a regular basis

Publicly traded royalty trusts

  • Highly liquid since there is an active trading market
  • No exploration risk
  • Net income passed through to investors
  • Minimal tax benefits available
  • Cash flow is normally distributed on a monthly basis

Drilling partnerships (may be issued through a private placement offering, but generally are not publicly traded)

  • Illiquid – no active trading market
  • High exploration risk
  • Income and expenses passed to investors
  • Beneficial tax attributes such as intangible drilling costs and depletion pass through to investors
  • Cash flow is normally distributed on a monthly basis

Direct investments in working interests

  • Illiquid – no active trading market
  • Exceptionally high exploration risk
  • All income paid directly to investor and expenses paid directly by investor
  • Beneficial tax attributes such as drilling costs and depletion
  • By definition working interests are non-passive (unless owned in an entity that limits liability)

Direct investments in royalties

  • Illiquid – no active trading market
  • No exploration risk
  • Income (net of severance tax and certain marketing/transportation cost) paid directly to investor
  • Investor is not responsible for exploration, development or production expenses
  • Beneficial tax attributes limited to depletion

Next, we’ll look at how accounting methods used for publicly traded oil stocks and Master Limited Partnerships (MLPs) can impact how the balance sheet, net income and cash flows are presented on financial statements. In other words, the accounting method can influence how well an investment vehicle appears to be performing.

Continue Reading: A Look at Accounting Methods of Developers

Scott Allen, CPA, joined Cornwell Jackson as a Tax Partner in 2016, bringing his expertise in the Construction and Oil and Gas industries and 25 years of experience in the accounting field. As the Partner in Charge of the Tax practice at Cornwell Jackson, Scott provides proactive tax planning and tax compliance to all Cornwell Jackson tax clients.

Contact him at or 972-202-8032.