Current Market Factors Impacting Economic Performance Of Oil And Gas Investments
Tangible costs related to drilling such as the costs of equipment used for drilling previously were 50% deductible in the year place in service with the remaining 50% being depreciated over seven years. With the passage of the Tax Cuts and Jobs Act (TCJA) passed in December 2017, tangible cost is currently 100% deductible when placed in service.
Prior to the COVID-19 pandemic, in February, oil production in the United States was approximately thirteen million barrels per day. When the pandemic hit in March, production decreased significantly due to a larger number of wells being temporarily shut, ceasing to produce. Additionally, many current drilling programs were suspended. As of August 17th, the production in the United States was around ten million barrels of oil per day.
Intangible drilling costs can include expenses associated with employees, mud drilling, supplies, chemicals, the fracking process, crews, and most expenses except for the actual drilling equipment (which is considered a tangible cost).
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Depletion allowances represent the method or recovering the cost of oil and gas mineral leases. On an annual basis, the greater of percentage depletion or cost depletion can be claimed as a deduction. Percentage depletion is calculated as fifteen (15%) percent of the gross oil and gas revenue and cost depletion is calculated by multiplying the oil and gas mineral lease cost by a percentage of annual production divided by the projected recoverable reserves remaining as of the end of the calendar year.
For example, assuming well costs are $8 million to drill and complete, and ultimate oil recovery equals 160,000 barrels of oil over the lifetime of the well, an oil price of approximately $50 per barrel would be required to recoup the cost of the well. This simple analysis ignores the time value of money and daily production rates. If the economics for drilling and development are not achievable in comparison to the ability for the well to recoup the cost, the well development program would not be initiated. Oil and gas commodity prices significantly impact the magnitude of active new well development and development of oilfields.
What does this mean? If an oil company owns oil and gas minerals acres situated in a basin that requires a break-even price of $45 per-barrel to develop the prospect, prudently the drilling must be delayed or placed on hold. The economics are pretty simple. What are the drilling and development costs of a well in comparison to the time frame oil and gas can be produced to recover the well drilling and development costs?
In March, JP Morgan stated the country would experience negative oil prices. Then, for the first time in the history of the oil and gas industry, a negative oil price was encountered as of April 21, 2020. A WTI (West Texas Intermediate) contract for May 2020 traded at a negative $37 per barrel. Today, JP Morgan predicts prices could reach $190 per barrel in 2025.
b) Deductions for intangible drilling costs (IDCs):
Examples of available income tax deductions enacted by Congress are as follows: