“[Working interests are] by far the riskiest and most involved way to participate in an oil and gas investment,” according to an article on Investopedia. Yes, a working interest in oil and gas can be a risky endeavor but as any successful investor will tell you, with great risk comes great reward. But what is a working interest in oil and gas?
Working Interest Oil and Gas Defined
Thanks to Blackbeard Data Services, we have this very clear definition of a working interest in oil and gas, “The easiest way to explain it is this: In every business there are expenses and there is income. The working interest is ownership of the expenses. Thus, if you own 50% working interest; it means you must pay 50% of the bills that are due for that lease. So if you own 10% working interest, you pay 10% of all bills.”
What this comes down to is that a working interest in an oil or gas well means you are in control; all the decisions, from exploration to marketing, are up to you to make. This isn’t an investment where you sit back and watch the stock market spike and fall. A working interest is an active investment that demands a keen understanding of the industry.
Types of Working Interest Oil and Gas
Furthermore, there are two types of working interest in oil and gas: operated and non-operated. “The working interest owner designated as the ‘Operator’ proposes wells, supervises drilling, and manages day-to-day operations, such as marketing and accounting functions associated with the lease,” according to W Energy Advisory. “Non-operating working interest owners are consulted on production decisions and incur part of the costs according to the agreements made between owners. However, non-operating working interest owners are not involved in actual operations.”
Sounds like a lot of work and possibly not a lot of return on investment? While it might not seem like a worthwhile way to use your money, a working interest in oil and gas can deliver a substantial return on investment. As detailed by the Schlumberger Oilfield Glossary, “Working interest owners are obligated to pay a corresponding percentage of the cost of leasing, drilling, producing and operating a well or unit. After royalties are paid, the working interest also entitles its owner to share in production revenues with other working interest owners, based on the percentage of working interest owned.”
Working Interest Oil and Gas Tax Benefits
Besides the obvious payoff if/when production revenues are generated, there are also tax benefits to investing in a working interest in oil and gas. “The US tax code specifies that a working interest (as opposed to a royalty interest) in an oil and gas well, is not considered to be a passive activity,” asserts W Energy Advisory. “This means that any losses act as active income incurred in conjunction with oil/gas production can be offset against other forms of ordinary income. “
In an effort to make oil and gas investments a more enticing proposition for American investors, the United States Congress enacted legislation to offer tax incentives. For example, tangible drilling costs for 100 percent tax deductible for a person with a working interest in oil and gas. “Once an economic interest is established, working interest owners may want to establish a tax partnership, such as a limited liability company, as an instrument to hold their interests,” advises Rebecca Pavese, CPA with Palisades Hudson Financial Group, LLC. “A working interest opens owners to greater liability than does a more passive investment, such as a royalty interest. As the name implies, an instrument such as a limited liability company offers a shield against such risks. Such protection flows both ways; the instrument can also protect the working interest from personal liabilities the owner may incur elsewhere.”
Working Interest Oil and Gas: Buy or Sell?
While the oil and gas market is beginning to recover from a tumultuous period of incredibly low prices, many wonder if now is the time to buy or sell working interests in oil and gas. Ultimately, it depends on how quickly an individual needs to see a return on their investment. At this time, it’ll be quite a while before production revenues are generated for those with a working interest in oil and gas. Basically, if you have a working interest in oil and gas, now is an ideal time to sell to unburden your portfolio from these steep operating expenses. As for buying a working interest in oil and gas, the upfront investment might be minimal but long-term costs could be exorbitant and more than you can pay before seeing a return.
As with any large investment, consult your financial advisor and accountant to ascertain if buying or selling a working interest in an oil and/or gas well is right for you. The oil and gas industry is not for the faint of heart, and investing in a working interest requires nerves of a steel, patience, and a keen business sense. For those who currently own a working interest, the market has recently been unkind to you, to say the least. Consider how selling your working interest would free up assets you could use to invest elsewhere.