There may be significant tax advantages associated with participation in privately held domestic oil and gas drilling and production in the U.S. today. The Internal Revenue Code of 1986, as amended (the “Code”) currently provides tax advantages for certain types of direct participation in oil and gas drilling and production in order to encourage investment in oil and gas exploration within the United States. However, in order to benefit from these tax incentives participants must meet certain requirements – not all oil and gas ventures generate the same types of tax advantages. This overview sets forth some of the tax benefits associated with participating in private oil and gas ventures within the United States. It is applicable only to participation in private companies – investing in a publicly traded stock does not generate the same types of tax advantages. Of course, you are encouraged to consult with your tax advisor regarding how any specific participation will be treated given your particular circumstances.

Intangible Drilling and Completion Costs (“IDCs”) generate significant deductions during the 1st year of participation.
IDC costs comprise a substantial portion of the expense associated with drilling and developing a well, and include drilling expenses, such as site preparation, rig costs and the expensive, high-pressure fracturing of rock formations. A substantial portion (approximately 65 to 80%) of a direct investment in a domestic oil and gas venture may constitute IDC and be deductible in the taxable year of the participation. This is even true for some investments made late in a year, in which the drilling doesn’t begin until the beginning of the following year. For example, if a participant were to purchase a portion of a U.S. working interest in December 2007, the IDC for that well generally could be deducted in 2007 as long as drilling begins prior to April 2008. For a participant in the 35% federal marginal tax bracket who has the ability to use the full write-off, this means a tax savings in the first year equal to 22.75% to 28% of the initial investment. As an illustration, if the IDC for a well amounted to 75.0% of a participant’s $100,000 investment, the participant could receive up to a $75,000 deduction. This would save the participant (at a 35% federal marginal rate) $26,250 on his or her taxes in the year of the investment. These tax benefits could be even more significant in states where there is a state income tax or for self-employed participants who could benefit from reduced self-employment taxes as a result of IDC deductions.

Participation in oil and gas ventures allows participants to offset other “Active” income.
The Code classifies participation in joint ventures formed to purchase working interests in oil and gas properties as an “active” business activity. This is beneficial because it allows individuals to offset losses stemming from oil and gas joint ventures against other income from “active” businesses. This classification allows participants to use deductions from certain oil and gas ventures against income from salaries, businesses in which they invest, stock dividends and stock trades. The same benefits are not associated with “passive” investments, such as investment in stock in corporations or limited partnership interests in limited partnerships formed to purchase oil and gas properties.

Participation may also generate depreciation deductions over time.
Equipment including pipe, well casings, tubing, storage tanks, pumping units and other items that remain with the well after its completion are considered depreciable. These additional expenses may generally be depreciated over a seven-year period.

Participants in domestic independent oil and gas ventures are entitled to a percentage depletion allowance.
The owner of an economic interest in an U.S. oil and gas property is generally entitled to claim the greater of “percentage depletion” or “cost depletion.” Percentage depletion is generally available only to the domestic oil and gas production of "independent producers." To qualify as an independent producer, the taxpayer, either directly or through related parties, may not be involved in the refining of more than 50,000 barrels of oil (or equivalent of gas) on any day during the taxable year or in the retail marketing of oil and gas products exceeding a total of $5 million per year. Although it could be higher, generally a percentage depletion allowance of 15% is used. In contrast, cost depletion for any year is determined by multiplying the cost basis of the mineral interest by a fraction, the numerator of which is the number of barrels of oil (or Mcf of gas) sold during the year, and the denominator of which is the estimated recoverable units of reserves available at the beginning of the depletion period. In no event may the cost depletion exceed the adjusted basis of the property to which it relates.

Consult your personal tax advisor.
The above examples are for general information only and are not intended as individual tax advice. Federal and state tax laws are complex. Consult your personal tax advisor concerning the applicability and effect participation in oil and gas ventures on your personal tax situation and, more specifically, whether or not participation in an oil and gas venture would produce favorable tax advantages in your tax situation. This information was current as of September 2007. However, tax laws change from time to time, and there can be no guarantee of the interpretation of the tax laws.

ACCREDITED INVESTOR
A person or institution deemed capable of understanding and affording the financial risks associated with the acquisition of unregistered securities.
The SEC recognizes the following parties as accredited:
1. An individual who alone, or with a spouse, has a net worth of over $1 million.
2. An individual who alone had income in excess of $200,000 in each of the past two years (or with a spouse, in excess of $300,000 in each of the past two years) and has a reasonable expectation of doing as well in the current year.
3. A financial institution such as bank, broker/dealer, insurance company or business development company.
4. Any director, officer or general partner of the issuer.
5. A trust or business partnership, with assets in excess of $5 million, that wasn't formed for the purpose of acquiring the unregistered securities.
6. Any entity wholly owned by accredited investors.

ACIDIZING
A technique for increasing the flow of oil and/or gas into a well. Hydrochloric acid is pumped into the oil-bearing rock. The acid dissolves limestone in the producing zone enlarging pores and flow into the well bore with less restriction.

BIT
A bit is the drilling tool that bores or cuts into the earth. There are two basic types: the cable tool bit which moves up and down the hole, striking the bottom, chipping away the rock, and the rotary bit which revolves to grind the rock. The rotary is the modern technique used in most drilling operations.

BLOWOUT
An unexpected violent eruption of oil and gas from a well during the drilling phase of operation. This happens when high pressure gas is encountered and the proper precautions have not been taken. The initial eruption is followed by an uncontrolled flow of fluids from the well.

BLOWOUT PREVENTER
A "BOP" is a large, specially designed valve that is mounted on top of the well during the drilling and completion stages of operation. The operator can close this valve to stop the flow of oil or gas in case of emergency.

BOTTOM HOLE PRESSURE
The reservoir pressure at the bottom of the well. When the well is flowed, a decline in pressure occurs. The amount of decline in pressure related to the amount of oil production will give an engineer information regarding the reserves of the well.

CASING
Steel pipe which screws together and is lowered into the hole after drilling is complete. It is used to seal off fluids and keeps the hole from caving in.

CEMENT OR "SET PIPE"
A process whereby cement is pumped into the hole between the walls of the hole and the outside of the casing. Upon hardening, the cement holds the pipe in place and prevents fluid movement in the hole.

COMMERCIAL WELL
A well which is capable of producing enough products to pay for itself and give a profit to its owners.

CUTTING OR SAMPLES
Pieces of rock cut out of the formation by the bit and circulated to the surface by the mud. Geologists study this rock for signs of oil and gas as the well is drilled.

DEPLETION
The reduction in value of mineral deposits as it is produced. Oil is a wasting asset, in that proceeds from the well represent both income and return of capital.

DEPOSIT
An accumulation of oil, gas or other minerals which is capable of production.

DEVELOPMENTAL WELL
A well drilled to a known producing formation in an existing oil field.

DISCOVERY WELL
An exploratory well which encounters production in a previously unknown deposit.

DRILLING
The act of boring into the earth.

DRILLING RIG
The equipment used to bore into the earth. There are two types: a. Rotary b. Cable tools. The rotary type is more modern and efficient.

ELECTRIC LOG
An electrical survey made on uncased holes. A special tool is lowered into the hole which ejects an electrical current into the rock and records its resistance to the current. The data from the survey is used by the geologist to determine the nature of the rock and its contents.

EXPLORATION
A general term referring to all efforts made in the search for new deposits of oil and gas.

FLOWING WELL
A well capable of producing oil or gas by its own energy without the aid of a mechanical pump. Normally a pump is put on the well after the pressure reduction inhibits the rate of production.

FRAQING
The process of pumping fluids into a productive formation at high rates of injection to hydraulically break the rock. The "fractures" which are created in the rock act as flow channels for the oil and gas to the well.

IDC (Intangible Drilling Costs)
All costs incurred in drilling a well other than equipment or leasehold.

IP
(Initial Production) Production from a well is generally broken down into three categories: a. Flush or Initial b. Settled c. Stripper. It is important for investors to realize that a well cannot maintain the flow rates it made during the first stages of its life.

NRI
(Net Revenue Interest) That percent of the production revenue allocated to the working interest after first deducting proceeds allocated to royalty and overriding interest.

OIL GRAVITY
The most widely used indicator of a crude oil's worth to the producer is its API gravity. Normally, the price which a producer receives for his oil depends on its gravity, the less dense oils (higher API gravity) being the most valuable. This price schedule is based on the premise that the lighter oil contains higher percentages of the more valuable products such as gasoline. API Gravity (degrees) = (141.5/sp.gr.) - 131.5.

PERMEABILITY
A measure of the resistance of rock to the movement of fluids. Rocks may have holes or void spaces in them (porosity), but if these holes do not connect, the permeability can be drastically reduced.

POROSITY
A measure of the relative volume of void space in rock to the total rock volume. These spaces or pores are where oil and gas accumulate; therefore, a formation containing a high percentage of porosity can contain more hydrocarbons.

SALT WATER DISPOSAL WELL
Many wells produce salt water while producing oil. The disposal of this water is a problem to an operator because of pollution. The best solution to the problem is to pump the waste back into a formation that is deep enough not to pollute shallow water sands. Many stripper wells which are no longer commercial are converted for this purpose.

STRUCTURAL TRAP
A fold or break (or both) in the earth's crust which creates an impervious trap for oil and gas. Oil will migrate underground through rock until it is "trapped".

SURFACE PIPE
Pipe which is set with cement through the shallow water sands to avoid polluting the water and keep the sand from caving in while drilling a well.

TESTING
When each new well is competed, a series of tests are run on the well. The various tests are used to estimate the daily deliverability, payout, and reserves.

TURNKEY CONTRACT
A contract in which an operator or drilling contractor agrees to furnish all labor and materials necessary to drill a well to a certain depth or stage of completion for a specified sum of money. The operator or contractor assumes all of the responsibility and risks involved in completing the operation.

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