Profit from the Explosion of Energy Prices

Physician's Money Digest, December 2005, Volume 12, Issue 16

Costs have retreated slightly,but if we have a colderthan normal winter, naturalgas prices will increasefurther. The crisisin natural gas supplies didn't ariseovernight. Annual demand for naturalgas in the United States has been increasingon average by 2.5% for thepast several years. Meanwhile suppliesof natural gas have been steadily decliningfor the past 6 years. The USnatural gas supply-and-demand curvescrossed each other in 2003 and priceshave skyrocketed ever since.

Unlike oil, which can be easilyimported from overseas by tanker, naturalgas is primarily transported bypipeline. To import natural gas, it hasto be cooled to -260°F, liquefied, andput into special insulated tankers.There are only four operational liquefiednatural gas (LNG) terminals in theUnited States, and these import terminalscan only provide 3% of our currentdemand. Lasting solutions to ournatural gas shortage include anAlaskan pipeline, additional LNGimport terminals, and drilling in areascurrently off limits in the United States,such as the eastern Gulf of Mexico, theRocky Mountains, and both the Eastand West Coast continental shelfwaters. However, all of these solutionswill take years to implement.

The picture for oil isn't much better.Many experts are predicting thatworld oil production is at or near peaklevels. Most of the world's known oilreserves are located in politically unstablecountries. US oil production hasdeclined steadily, from 10 million barrelsper day in the 1980s to less than 5million barrels today. History provesthat once a country's oil productionpeaks, there is no way to stop the long-termdecline in production.

Natural Gas Profits

For natural gas, I like investments indevelopmental natural gas programslocated in the Appalachian basin areaof western New York, Pennsylvania,and West Virginia. These programsprovide huge tax incentives and significantannual cash flow returns on yourinvested capital. At current natural gasprices, these programs can easily return25% to 50% annual cash returnson your investment.

There are key features to look for inthese programs. The program shouldprovide a 100% tax deduction for thefunds you invest. Check that the drillingcompany is putting up at least 30% ofthe capital to drill the gas wells. Investonly in developmental gas wells—theseare wells drilled in current proven gasfields with very little dry hole risk.Make sure the program has at least 15to 20 gas wells, thus turning the programinto a "mutual fund"of gas wellsto diversify your drilling exposure. Also,make sure the drilling company has asolid long-term track record and ischarging competitive prices to drill,manage, and operate the gas wells inyour program. Depending on your stateand federal income tax rates, you canreceive up to 50% of your money backimmediately from these programs in taxsavings, plus a continuing annualstream of cash flow from the sale of gasfrom your wells for years to come.

Oil Opportunities

The best opportunity I have seen inover 20 years as an investor in oil andgas drilling is taking place right now inthe Gulf of Mexico. The outer continentalshelf (OCS) is the extension ofthe North American continent into theGulf of Mexico and ranges in widthfrom 5 to 200 miles off the coastof Texas and Louisiana. At drillingdepths of less than 15,000 feet, the oiland gas reserves on the OCS havelargely been discovered and developed,with over 50,000 wells drilled in thepast 50 years.

Until recently, oil and gas companiesdid not drill deeper than 15,000feet on the OCS because it was toorisky. However, in the past 5 to 7 years,drilling technology has improved dramatically,and oil and gas companiesare now successfully drilling as deep as25,000 feet. In effect, a 2-mile-thickhorizon that covers the entire OCS hasnow been successfully opened toexploration and development.

This type of investment requires alarge capital commitment by aninvestor—in the range of $300,000 to$500,000 spread out over severalyears—in order to successfully diversifyaway most of the exploratorydrilling risk. Investors willing to makethis kind of commitment can reasonablyexpect two substantial investmentbenefits: a 100% tax write-off for thefull amount of your investment spreadover the time it takes to put your capitalto work drilling wells, and annualcash returns on your investment for 10to 15 years exceeding 50% annually.

Although drilling costs have risen inrecent years, energy prices have faroutstripped these cost increases. Therehas never been a better time to own adirect interest in oil and gas productionin the United States—and it looks likethis opportunity will last for some timeto come. Not only will you profithandsomely from your investment,you will take some of the sting out ofhigh gasoline and heating bills andhelp benefit the US economy by makingour country less dependent on foreignenergy sources.

, a former tax attorney, is president

of Alliance Affiliated Equities Corporation,

an NASD-registered broker/dealer

specializing in the evaluation and acquisition

of direct investment, including oil and

gas partnerships. He welcomes questions or comments at

800-453-5155.

David P. Dyer