What is Commercial Well

A commercial well is any oil or gas drilling site that produces enough oil or gas to be commercially viable. All wells that investors are willing to put money into are considered to be commercial wells. Sites with non-producing wells fall outside this category, as do sites with only one or two wells, unless their production is extremely high on a consistent basis.

Understanding Commercial Well

The number of commercial wells in the US was 729,000 in 2000 and jumped to a high of 1,035,000 wells in 2014. It fell to 982,000 in 2017 due to lower oil prices.

A commercial well is often a popular investment because they are inherently profitable. Limited partnerships typically will syndicate a share of a commercial well. In addition, owners of working interests and those who receive royalties also invest in commercial wells.

Limited partnerships are also commonly known as a direct participation program. They are a tax structure that holds certain types of investments, such as interests in oil and gas projects, land and real estate. Investors in this kind of structure participate directly in the success or failures of the investment. Investors receive a share of the income, gains, losses, deductions and tax credits of the entity, which is structured as a limited partnership or subchapter S corporation, in this case the commercial well. Partnerships have a limited life and limited transferability of share interests.

An example of the tax benefits accruing to investors from putting their money into oil and gas projects is the Intangible Drilling Cost (IDC). Intangible costs are costs that are incurred in preparation for drilling. Such costs pertain to work or equipment that cannot be salvaged. They generally include wages, fuel etc. The IDC enables such projects to claim hefty tax deductions, amounting to as much as 80% of a project's total cost during an investment year. Thus, $100,000 invested in an oil drilling project could give the investor tax deductions of as much as $80,000.

Key Takeaways

  • A commercial well is an investor-funded oil or gas drilling site that produces enough oil or gas to be commercially viable.
  • Typically limited partnerships syndicate a share of commercial wells to gain tax benefits from the transaction.
  • The number of commercial wells in operation within the United States has jumped with a corresponding increase in the oil output.

Terminology for Oil and Gas Investors

When investing in oil and gas, it helps an investor to understand a little of the vocabulary that is used in the oil and gas industries. Along with commercial wells, there are exploratory wells and development wells.

An exploratory well is a deep test hole drilled by oil and gas exploration companies to locate proven reserves of recoverable gas and oil, both onshore and offshore. Areas that might contain oil or gas reserves are first identified using seismic data before exploratory wells are used to gather more detailed geological data on rock and fluid properties, initial reservoir pressure, reservoir productivity, etc. If oil or gas is discovered, a development well will be eventually be drilled to extract the oil. It typically takes several years before an exploratory well can be brought into production.

A development well is a well drilled in a proven producing area. It is drilled to a depth that is likely to be productive, so as to maximize the chances of success. Development wells are drilled with various different objectives, such as flowing production, artificial lift production, injection of water or gas and to monitor the performance of a well. The costs of dry development wells are usually capitalized as an asset on the balance sheet, whereas the costs associated with dry exploratory wells are immediately expensed on the income statement under International Financial Reporting Standards and United States Generally Accepted Accounting Principles.