Oil, gas tax shelters regain some lost status.
If you're thinking of investing in a tax shelter this year and you're in a high tax bracket and you're willing to take a risk, you might consider an oil and gas deal.
Despite the oil glut and two years of falling oil prices that have made investors shun these deals, oil and gas programs are quietly staging a comeback. Hostilities in the Persian Gulf and the threat that the conflict poses to world oil prices is leading some investors to look again at these shelters.
''They are still a viable vehicle for investment,'' maintains Edward B. Kostin, a tax partner in the Boston office of Coopers & Lybrand, an accounting firm.
The market for oil and gas tax shelters is changing. The downturn in the energy industry has caused a shift in investment away from higher risk exploration deals to lower risk acquisition of producing wells.
''Investors have clearly become more conservative,'' says Arthur Jerrold King , president of Investment Search Inc., an Annapolis, Md., research firm that tracks such investments. ''When the economy slides they are more interested in avoiding loss than in the potential of a bigger gain.
Typically, oil and gas deals use investors' money to drill wells. There are three types of oil and gas drilling partnerships: highly speculative exploratory well drilling for new wildcat wells, the riskiest type; balanced partnerships, a combination of developmental and exploratory enterprises; and developmental drilling, the least risky of all.
These shelters usually last from 10 to 15 years. They give you most of your deductions in the first year or two and income after that in the form of revenues from the sale of oil and gas, which also has some tax advantages. First-year write-offs on the oil and gas drilling ventures can be as high as 70 percent to 100 percent of the taxpayer's investment in the first year. The new tax law does away with year-end deals.
A successful drilling program might pay out a total annualized after-tax return of 15 percent; an especially successful partnership might pay much more.
Oil and gas shelters are for investors who can afford the high risk - your well might end up being a dry hole - generally people in the 50 percent bracket ($162,400 for those filing a joint return). The minimum investment is $5,000 for a public offering on a drilling venture and normally higher for a private program.
The glut and lower product prices have caused a sharp decline in the sales of drilling shelters that raise money to dig new holes. According to Robert A. Stanger, head of his own tax shelter research firm in Shrewsbury, N.J., drilling fund programs collected just $766 million in 1983 and were down 37 percent in the first half of 1984 from the same period in 1983.
On the other hand, sales of oil and gas income programs - those that acquire already-producing oil and gas wells - fared better, raising more than $3 billion in 1982 and 1983.
Their popularity stems from the fact that they are income, rather than deduction-oriented, and thus appeal to a greater pool of individuals setting up individual retirement account and Keogh plans. Also, several oil income funds have reduced their minimum investment to as low as $2,000 to attract such deposits.
Several companies dominate the oil income market. Damson Oil Corporation of New York raised $537 million in 1983, garnering a 27 percent market share. Petro-Lewis Inc. of Denver raised $484 million, capturing 24 percent of the total market. A distant third, Natural Resource Management Corporation, raised $ 240 million for 12 percent of the market.
Other good oil and gas sponsors that have offered top-performing programs over the past 10 years include Sampson Properties, Saxon Oil, Belden & Blake, and Magic Circle Energy.
Because of overextension created by borrowings, Petro-Lewis has withdrawn from the marketplace. Damson in 1984 continues to be the leader, followed by Natural Resource Management and Quinoco Oil & Gas.
For those who want to start out dabbling in oil there is a new breed of publicly traded ''master'' partnership, such as those offered by Apache, May Petroleum, and Transco Energy Partners. These partnerships offer better liquidity by trading like stocks, but they pass on tax benefits similar to existing partnerhsips.
Wall Street is getting into the act in both the drilling and income fund area. Among new entrants are Merrill Lynch Energy Management, Hutton/Indian Wells Energy Income fund, and Kidder Peabody Templeton Oil and Gas Income Fund, all subsidiaries of major brokerage firms.
''Perhaps this is an indication that the brokerage houses in New York are dissatisfied with the records of the companies run by the oil people, and they feel that they can do better themselves,'' Mr. King, of Investment Search, said.
''We are hopeful,'' he continued, ''that the brokerage firms' personnel turn in better results for their investors, but I haven't seen anything in these deals that solves the basic problem of the drilling programs. The only real difference is that the Wall Street firms get a share of the revenues in addition to the 8 percent commissions that they get in selling other people's deals.''
Conventional drilling programs, which search for new oil, are not as complicated as income programs, but choosing a sponsor from the bewildering array of programs can be difficult. One thing you should always consider is a program's investment risk.
Exploratory well drilling for new fields has much less chance of producing a gusher than developmental drilling of wells near producing fields. William G. Brennan, a Valley Forge, Pa., tax shelter expert, estimates only 20 to 25 percent of exploratory wells will be successful, while more than 60 percent of developmental wells prove successful. The skill of the general partner and the company's geological adviser are important for the program's success.
Costs and deductions should be allocated along functional lines. The most common cost and revenue sharing setup provides that. The limited partners pay the intangible drilling and developmental costs and other immediately deductible items, while the general partner should pay the tangible costs of acquiring property or equipment.
The general partner shares in up to 35 percent of the revenues; the remainder is allocated among the limited partners according to their shares.
Stanger's statistical approach to finding out what share of the oil and gas revenues a limited partner will get measures the ''front-end load,'' which consists of brokerage commissions, offerings and organizational costs, management fees, and first-year general and administration expenses.
Two other areas it measures are the general partner's share of the drilling costs, and his share of the revenues from the producing wells. The higher the rating, the better it is for the investor, and Stanger's analysis shows a range from a low of 2.03 or 2.04 to a high of 3.02.
This spread represents a difference of 40 percent in oil finding capability. In other words, a company with the lowest rating would have to find 40 percent more oil to provide the same economic returns to investors as a company with the highest rating.
Investment Search, in a study of 500 partnerships formed before 1981, found that the average expected rate of return for all the partnerships was 9.9 percent, down from 12.1 percent in 1980.
The study also showed that 21.2 percent (vs. 18 percent in 1980) of the programs had an opportunity to achieve an after-tax return of more than 20 percent. In approximately 25 percent of the programs, the firm discovered, the chances of a payout on an after-tax basis were negligible.
So proceed with caution.
''While money can be made in oil and gas, selectivity is the key,'' stressed Mr. King, who has devleoped a 17-point rating program and feels that investors should only seriously consider those that have a four-star rating.
Despite declining prices, there are signs the economics are improving for drilling programs. True, oil and gas prices are down. But the cost of drilling is typically down 40 percent to 50 percent from its peak in 1981 because the world oil glut has so sharply reduced activity. Thus, the profit margin on the sale of oil and gas is greater than it was several years ago.
Another plus: the windfall profit tax on newly discovered oil is being reduced in stages from 30 percent to 15 percent after 1985.
Forgetting speculation, oil and gas tax shelters are beginning to look more attractive. What's more, since sales have been slower than ever, it's a buyer's market. So if you're looking for leases, acreage blocks, and participations in wells, there are plenty of choices available.