Buying PDP and Cash Flow Certainty
Cash Flow certainty in oil and gas investing is focusing capital toward purchasing Mineral Rights over proven Reserves where completed and functioning oil and gas extraction methods are producing saleable oil and gas — and where the continuation of doing so can be examined, verified, and deemed profitable, in scale and volume, in the current and expected economic environment.
Preamble: Most think of oil and gas investing as highly speculative, but it doesn’t have to be. In fact, buying Working Interest in existing oil and gas wells with a history of consistent production can offer investment certainty for a specific and measurable period of time. Further, many choose to invest in real estate which offers security of a tangible asset by way of assuming title or ownership in a specific property, and real estate investors can also boast of tax advantages in that real estate investments can be depreciated for wear-and-tear all while most real estate assets appreciate in value over time. Similarly, existing oil and gas producing wells (and Leases consisting of many wells) are also tangible assets which can be bought and sold and where title of ownership can be transferred, recorded, and pledged to banks and financiers as collateral or security for capital borrowings. Moreover, existing wells can also be depreciated (above ground equipment and assets) and where the Reserves (or the below ground Mineral Rights asset owned by the investor) also offer an extra tax advantage in the form of Depletion (see IRS Tax Code 613(a)). Unlike typical real estate depreciation where the land itself cannot be included in a depreciation schedule (as only above-ground improvements can be subject to depreciation), Depletion allows for a deduction of the Mineral Rights, or oil and gas Reserve value, over an adopted and approved period of time, while additional Reserves may be discovered, new wells drilled over the existing Reserves, or additional oil and gas producing zones from the same Reserves may be entered and exploited which typically increase the value of the same property.
Oil and gas has its own vernacular and series of acronyms that help those in the industry quickly and effectively communicate. Below are just a few that are the focus of our approach to qualifying and investing in oil and gas assets which includes identifying and mitigating risk.
Proved Developed Producing (PDP): are known and existing oil and gas Reserves wherefrom oil and gas is currently being extracted from various identified, measured, and named Reserve zones, and where oil and gas extraction is expected to continue via present completed operating methods.
Proved Developed Non-Producing (PDNP): are known and existing oil and gas Reserves where oil and gas is proved to exist, could be extracted from various identified, measured, and named Reserve zones, but where the extraction equipment is not active, or in state of longer-term disrepair awaiting further completion, and for pending extraction to reengage or to begin anew.
Proved Un-Developed (PUD): are known oil and gas Reserves where oil and gas has been proven to exist and could be extracted from various identified, measured, and named Reserve zones, but where the wellbore(s) have not been developed or completed, and where the extraction equipment has not been installed nor activated.
Cash Flow certainty in oil and gas investing, then, is the result of focusing capital toward purchasing Mineral Rights of proven Reserves where completed and functioning oil and gas extraction methods are producing saleable oil and gas, and where the continuation of doing so can be examined, verified, and deemed profitable, in scale and volume, in the present and expected economic environment.
Look for other Blog posts for my take on Focused Due Diligence and how best to identify quality oil and gas assets that offer consistent and sustainable long-term cash flow.
