Oil and Gas Investment Glossary, Definitions and Terms
1031 Exchange: The sale or disposition of real estate or personal property (relinquished property) and the acquisition of like-kind qualified use real estate or personal property (replacement property) in a transaction structured as a tax-deferred, like-kind exchange pursuant to Section 1031 of the Internal Revenue Code and Section 1.1031 of the Treasury Regulations. The purpose of a 1031 exchange is to defer Federal, and in most cases state, depreciation recapture and capital gain income tax liabilities.
Barrel of Oil: 42 U.S. gallons of oil at 60 degrees Fahrenheit.
Crude Oil: Oil in its natural state of composition. "Crude" is classified according to its physical properties:
Depletion: The reduction in value of mineral deposits as it is produced. Oil is a wasting asset, in that proceeds from the well represent both income and return of capital.
Developmental Well: A well drilled to a known producing formation in an existing oil field.
Discovery Well: An exploratory well which encounters production in a previously unknown deposit.
Division Order: A contract with a purchaser of oil and gas which directs the payments of oil and gas revenues to the interest owners of a well.
Drilling: The act of boring into the earth.
Drilling Rig: The equipment used to bore into the earth. There are two types of drilling rigs:
The rotary type is more modern and efficient.
D&A: Dry and abandoned.
Electric Log: An electrical survey made on uncased holes. A special tool is lowered into the hole which ejects an electrical current into the rock and records its resistance to the current. The data from the survey is used by the geologist to determine the nature of the rock and its contents.
Exchange: The sale or disposition of real estate or personal property (relinquished property) and the acquisition of like-kind qualified use real estate or personal property (replacement property) in a transaction structured as a tax-deferred, like-kind exchange pursuant to Section 1031 of the Internal Revenue Code and Section 1.1031 of the Treasury Regulations. The purpose of a 1031 exchange is to defer Federal, and in most cases state, depreciation recapture, depletion, and capital gain income tax liabilities.
Exploration: A general term referring to all efforts made in the search and discovey for new oil and gas deposits.
Flowing Well: A oil or gas well capable of producing oil or gas by its own energy without the aid of a mechanical pump. Normally a pump is put on the well after the pressure reduction inhibits the rate of production.
Fracing: The process of pumping fluids into a productive formation at high rates of injection to hydraulically break the rock. The "fractures" which are created in the rock act as flow channels for the oil and gas to the well.
Gas Well: A well that produces natural gas which is not associated with crude oil.
IDC: Intangible Drilling Costs. All cost incurred in drilling a well other than equipment or leasehold interests. These expenses are 100% tax deductible even if the well is productive.
Initial Production (IP): Production from a well is generally broken down into three categories: a. Flush or Initial b. Settled c. Stripper. It is important for investors to realize that a well cannot maintain the flow rates it made during the first stages of its life.
Intangible Drilling Costs (IDC: All cost incurred in drilling a well other than equipment or leasehold interests. These expenses are 100% tax deductible even if the well is productive.
Intermediary: An unrelated third party (i.e. Exeter 1031 Exchange Services, LLC) that administers the tax-deferred, like-kind exchange transaction in order to facilitate the disposition of the Investor's relinquished property and the acquisition of the Investor's like-kind replacement property. The Intermediary has no economic interest except for any compensation (exchange fee) it may receive for acting as an Intermediary in facilitating the exchange as defined in Section 1031 of the Internal Revenue Code. The Intermediary is technically referred to as the Qualified Intermediary, but is also known as the Accommodator, Facilitator or Intermediary.
IP: Initial Production. Production from a well is generally broken down into three categories: a. Flush or Initial b. Settled c. Stripper. It is important for investors to realize that a well cannot maintain the flow rates it made during the first stages of its life.
Net Revenue Interest (NRI): That percent of the production revenue allocated to the working interest after first deducting proceeds allocated to royalty and overriding interest.
Non-Commercial: A well that is not capable of producing enough oil to pay for the drilling.
NRI: Net Revenue Interest. That percent of the production revenue allocated to the working interest after first deducting proceeds allocated to royalty and overriding interest.
Oil: A liquid hydrocarbon. (also see "Crude Oil")
Oil Gravity: The most widely used indicator of a crude oil's value or worth to the producer is its API gravity. Normally, the price which a producer receives for his oil depends on its gravity, the less dense oils (higher API gravity) being the most valuable. This price schedule is based on the premise that the lighter oil contains higher percentages of the more valuable products such as gasoline.
Oil and Gas Leases: A contract between an oil operator and a landowner which gives the operator the right to drill for oil and gas on his property for a consideration. It is simply a "ticket to hunt".
On the Pump: An expression that means a well is incapable of flowing and that the oil is being pumped to the surface by a "pumping unit".
Operating Expense: The expenses incurred through the operation of producing properties.
Payout: When the costs of drilling, producing and operating have been recouped (cost recovery) from the sale of products on a well.
Permeability: A measure of the resistance of rock to the movement of fluids. Rocks may have holes or void spaces in them (porosity), but if these holes do not connect, the permeability can be drastically reduced. A measure of the relative volume of void space in rock to the total rock volume. These spaces or pores are where oil and gas accumulate; therefore, a formation containing a high percentage of porosity can contain more hydrocarbons.
Proven Reserves: Oil and gas which has not been produced but has been located and is recoverable.
Pumper: An employee of an operator who is responsible for gauging the oil and gas sold off the leases he has been assigned and who is also responsible for maintaining and reporting the daily production.
Qualified Intermediary: An unrelated third party (i.e. Exeter 1031 Exchange Services, LLC) that administers the tax-deferred, like-kind exchange transaction in order to facilitate the disposition of the Investor's relinquished property and the acquisition of the Investor's like-kind replacement property. The Intermediary has no economic interest except for any compensation (exchange fee) it may receive for acting as an Intermediary in facilitating the exchange as defined in Section 1031 of the Internal Revenue Code. The Intermediary is technically referred to as the Qualified Intermediary, but is also known as the Accommodator, Facilitator or Intermediary.
Real Estate Investment Trust (REIT): A trust or association that invests in a variety of real estate investment assets. REITs are managed by one or more trustees, like a mutual fund, and trade like a stock. No federal income tax is paid by the trust if at least 75% of the income is real-estate related and 95% of the income is distributed to investors. Individual investors can be taxed.
Rework Operations: Any major operation performed on a well after its completion in an attempt to restore or improve its ability to produce.
Salt Water Disposal Well: Many wells produce salt water while producing oil. The disposal of this water is a problem to an operator because of pollution. The best solution to the problem is to pump the waste back into a formation that is deep enough not to pollute shallow water sands. Many stripper wells which are no longer commercial are converted for this purpose.
Secondary Recovery: A broad term encompassing any method of extracting oil from a reservoir after a well or field has exhausted its primary production.
Sedimentary Rocks: Rock is generally classified in one of three categories: a. Sedimentary; b. Igneous; c. Metamorphic.
Settled Production: The second phase of production in the producing life of a well. (also see "IP").
Stripper Well: The final state in the life of a producing well.
Structural Trap: A fold or break (or both) in the earth\'s crust which creates an impervious trap for oil and gas. Oil will migrate underground through rock until it is "trapped".
Surface Pipe: Pipe which is set with cement through the shallow water sands to avoid polluting the water and keep the sand from caving in while drilling a well.
Swab: A tool which is lowered down the pipe on a wire line. The "swab" is then pulled out of the hole. As it travels up the pipe, rubber elements expand so that the fluid in the pipe is trapped above the swab and pushed to the surface. This operation is necessary when the formation pressure is not high enough to blow the fluids in the pipe to the surface.
Tank Battery: A group of tanks at a well site used to store oil prior to sale to a pipeline company.
Testing: When each new well is competed, a series of tests are run on the well. The various tests are used to estimate the daily deliverability, payout, and reserves.
Tubing: Small diameter pipe which is installed in the casing. Oil is produced through tubing because it increases the viscosity of fluid and a well\'s flow capabilities.
Turnkey Contract: A contract in which an operator or drilling contractor agrees to furnish all labor and materials necessary to drill a well to a certain depth or stage of completion for a specified sum of money. The operator or contractor assumes all of the responsibility and risks involved in completing the operation.
Viscosity: The resistance of fluid to flow. A high viscosity fluid will not flow as easily as a low viscosity fluid (Mud will not move as easily as water).
Water Flooding: A secondary recovery method for the production of oil from a formation. Oil will float on water. When water is injected into some formations, the oil will float or be washed to the surface, thereby, increasing the amount of production from a well or field. Some formations will not react to this type of stimulation.
Wild Cat: A well that is drained one or more miles from a proven well.
Working Interest: Oil and Gas Working Interests.
A working interest in an oil or gas property held by the taxpayer directly or through an entity that does not limit the liability of the taxpayer is not treated as a passive activity, whether or not the taxpayer materially participates in the activity. Thus, an owner of a working interest in oil or gas property is permitted to deduct otherwise allowable losses attributable to the working interest against other income without limitation under the passive loss rule.
A working intertest in an oil or gas property is one that is burdened with the cost of development and operation of the property, such as the responsibility to share expenses of drilling completed or operating oil and gas property, according to working or operating mineral interest in any tract or parcel of land. Rights to overriding royalties, production payments, and the like do not constitute working interests because they are not burdened with the responsibility to share expenses of drilling, completing, or operating oil and gas property. Likewise, contract rights to extract or share in oil and gas, or in the profits from extraction, without liability to share in the costs of production do not constitute working interests. Income from such interests is generally considered to be portfolio income.
A special rule applies in any case where, for a prior tax year, net losses from a working interest in a property were treated by the taxpayer as nonpassive losses by reason of the working interest exception. In such case, any net income realized by the taxapayer from the property (or any substituted basis property) in a subsequent year also is treated as active income. For example, suppose a taxpayer claimes losses with regard to a working interest that starts to generate net income. If he transfers the interest to an S corporation in which he is a shareholder or to a partnership in which he is a limited partner, the income will continue to be nonpassive. The income from that interest may not be offset by other passive activity deductions.
IN GENERAL -- The term "passive activity" shall not include any working interest in any oil or gas property which the taxpayer holds directly or through any entity which does not limit the liability of the taxpayer with respect to such interest.
INCOME IN SUBSEQUENT YEARS -- If any taxpayer has any loss for any taxable year from a working interest in any oil or gas property which is treated as a loss and is not from a passive activity, then any net income such as property (or any property the basis of which is determined in whole or in part by reference to the basis of such property) for any succeeding taxable year shall be treated as income of the taxpayer which is not from a passive activity. If the preceding sentence applies to the net income from any property for any taxable year, any credits allowable under subpart B (other than section 27(a) or D of part IV of subchapter A for such taxable year which are attributable to such property shall be treated as credits not from a passive activity to the extent that the amount of such credits does not exceed the regular tax liability of the taxpayer for the taxable year which is allocable to such net income.
Write-Offs: That portion of an oil investment which is deductible for tax purposes. All intangibles are deductible.