What is an AFE in an Oil & Gas Investment?

Introduction

For those participating as working interest investors in oil and gas projects, few documents carry more weight than the Authority for Expenditure, or AFE. Though it may appear to be a straightforward budget sheet, the AFE is one of the most critical instruments that governs how your capital is used, how risk is shared, and how returns are ultimately realized.

Unlike royalty interest owners who simply collect a share of production revenue, working interest investors are active financial participants. They are responsible for their share of project costs—and reap the corresponding share of production and profits. The AFE is the formal mechanism by which operators notify and seek approval from those investors before spending money on specific activities such as drilling, completing, or reworking a well.

If you’re entering or already involved in a working interest partnership, understanding AFEs is essential to protecting your capital, managing risk, and ensuring alignment with your investment strategy.

What is an AFE in a Working Interest Project?

An Authority for Expenditure is a formal document issued by the operator of an oil and gas project that outlines the estimated costs and scope of a proposed operation. It is sent to all non-operating working interest partners to obtain their approval—or at least a record of their consent or non-consent—before funds are committed.

Typical operations that require an AFE include:

• Drilling a new well
• Reworking or recompleting an existing well
• Installing or modifying production facilities
• Conducting major repairs or abandonment work

The AFE contains several key elements:

• Project description: What the operator plans to do and why.
• Estimated costs: A breakdown of expected expenses, often itemized by category (drilling, casing, fracking, completion, surface facilities, etc.).
• Working interest shares: Each party’s financial obligation based on their ownership percentage.
• Timing: A proposed schedule for the work.
• Approval deadline: A specified window in which non-operators must respond.

In many cases, AFEs are issued in accordance with a Joint Operating Agreement (JOA), which outlines how decisions are made and what happens if a party chooses not to participate in a given operation.

Why AFEs Matter to Working Interest Investors

As a working interest owner, you are not a passive recipient of revenue—you’re a business partner in every project you invest in. Your capital is at risk alongside the operator’s and other investors’. The AFE is the primary tool you receive to evaluate what that risk looks like, and whether the opportunity aligns with your investment goals.

Here’s why AFEs are so important:

They Define the Financial Commitment

The AFE is where the rubber meets the road. It tells you how much money is being asked of you, what it will be used for, and what the anticipated outcomes are. This allows you to assess whether the expected return justifies the expense—and whether you want to participate at all.

They Provide Cost Control and Transparency

AFEs promote accountability. They require the operator to present a reasoned estimate before spending investor money. Once a project is complete, actual costs can be compared against the AFE to identify overruns or unexpected savings. This ongoing visibility is essential for monitoring operator performance and maintaining financial discipline.

They Help You Manage Portfolio Risk

Working interest investors often participate in multiple wells or projects. AFEs help you track and prioritize your capital exposure. By comparing proposed costs, expected outcomes, operator track records, and geological risk, you can make more informed decisions about where to allocate funds—and where to hold back.

Breaking Down AFE Costs

When you receive an AFE (Authority for Expenditure) as a working interest investor, the most immediate and important detail is the cost estimate. But not all costs are the same, and understanding how they’re categorized can help you better evaluate the financial and technical risk of a proposed operation.

Operators break down costs in AFEs to provide transparency and to give investors like you a clearer picture of where capital will be spent. These categories also help in benchmarking, tracking spending as the project progresses, and understanding cost overruns—if they occur.

Generally, all of the costs in an AFE can be broken down into two categories for tax purposes: tangible drilling costs and intangible drilling costs.

Tangible Drilling Costs

Tangible costs result in the acquisition of physical, salvageable assets. These are capital expenditures that are typically depreciated over a number of years according to the asset’s class life and tax rules.

Examples of tangible costs in an AFE include:

• Casing and tubing
• Wellhead and Christmas tree
• Production tanks
• Separators and meters
• Flowlines and gathering systems
• Electrical and surface infrastructure
• Pump jacks or artificial lift systems

These costs are generally depreciated using schedules set by tax authorities (such as MACRS depreciation in the U.S.), meaning the deduction is spread out over time.

Intangible Drilling Costs

Intangible costs are expenses that don’t result in a physical asset but are necessary to drill and prepare the well for production. These costs are often incurred before the well is proven productive, and include labor, services, and consumable materials that are not salvageable.

Examples of intangible costs in an AFE include:

• Site preparation and surveying
• Drilling rig labor and service contracts
• Drill bits and drilling mud
• Cementing and logging services
• Directional drilling and geosteering
• Fracturing (fracking) fluids and services
• Well perforation services
• Environmental compliance and permitting

For tax purposes, in jurisdictions like the U.S., these Intangible Drilling Costs (IDCs) can often be expensed in the year they are incurred, which is particularly attractive for individual or pass-through investors.

Contingency and Risk Allowance

Many AFEs include a contingency line item—a financial buffer intended to cover unexpected issues like mechanical failure, unexpected formation pressure, or bad weather delays. While not all AFEs itemize contingency in the same way, investors should look for:

• Whether contingency is included at all
• If the percentage is realistic given the project’s complexity
• Whether there’s a process for issuing a supplemental AFE if the contingency is exceeded

A well-managed contingency shows prudence on the operator’s part. As an investor, it protects you from surprise capital calls or misaligned expectations.

Abandonment and Reclamation

Some AFEs, particularly for new well development or late-life wells, include an estimate of abandonment costs. These cover the eventual plugging of the well and restoring the surface site to its original condition.

Though not always included in initial AFEs, abandonment is a real liability that working interest investors are responsible for—either now or later. It’s wise to factor this cost into your full-cycle economics.