In exploration and production of oil and gas minerals you have various types of ownership. In the most simplest form, you can operate or let someone operate an oil and gas well. We are going to focus on the three types of ownership:
Owning mineral rights is the highest from of ownership in oil and gas exploration. Before anyone is able to exploit and produce oil and gas (or any form of minerals) they have to either purchase or lease the rights from the mineral owner. Typically, an oil and gas company will establish a lease agreement with the mineral owner.
The lease agreement outlines the terms of exploration and production, a certain time-frame (typically 3 years) that the oil company claims the rights to the minerals, and a revenue sharing agreement; otherwise known as the division of royalty interest (for the mineral owner) and working interest (for the oil company).
Just as well as no one is able to exploit the minerals until having an agreement in place with the mineral owner, no one receives revenue generated from any producing oil and gas wells until the mineral owner receives his agreed upon royalty interest.
Being able to participate in oil and gas exploration and production, without the costs and liabilities involved in drilling, has made many individual investors take the necessary steps to securing minerals for their family trust, individual accounts, and/or their self-directed IRA.
An overriding royalty interest (ORRI) owner has much of the same benefits as the mineral owner. Nevertheless, the ORRI is does not own the mineral rights, like the mineral owner does.
The ORRI owners can only claim the rights to a set ownership interest, agreed to in a lease agreement, of the production and sale of the oil and gas minerals. This means, should the mineral lease expire either due to term or not being able to commercially produce oil and gas, the ORRI will expire as well.
The working interest (WI) owner is the one that makes everything happen. They carry all exploration and production cost, liabilities of the entire operations, and responsibility to get the product (oil and gas) to market. The government backs domestic energy production and provide tax benefits to the high risk takers – working interest owners.
100% of intangible drilling costs (IDC), which generally constitute 65%-80% of the total drilling cost are deductible in the year incurred. In addition, 100% of tangible drilling costs can be depreciated over seven (7) years. And one of the final tax advantages is that all working interest income is considered active income, and thus can be offset against other forms of income (wages, interest, and capital gains).
Even though, a working interest (WI) owner is dealing with a high risk investment to explore and produce oil and gas, the benefits have triggered many individual investors to take advantage of the tax benefits, as well as the high returns a well can return.