Oil & Gas 101: Tax Benefits, How-To & more with Brad Updike of Mick Law, PC
We're diving into a new area of interest: Oil & Gas Investing.
If you’ve ever wondered about the differences between drilling programs and royalty programs, how to spot a quality operator, or why oil and gas remain such a compelling option for accredited investors seeking both tax advantages and portfolio diversification, this conversation is for you.
Brad Updike, LLM, JD joins us from Mick Law PC, a premier oil and gas due diligence firm, to explain.
Key highlights you don’t want to miss:
Oil & Gas 101:
Brad explains why oil and gas is the 7th largest industry globally and why its market fundamentals continue to attract smart capital.
Investment Structures Explained:
Learn the difference between investing in public oil and gas securities (like Exxon and Devon) versus private placements—including limited partnerships and mineral rights deals.
The Power of Tax Benefits:
Discover how investors can utilize intangible drilling costs (IDCs), tangible equipment deductions, and percentage depletion to substantially lower their tax liability. Brad breaks down real-world scenarios of how these can shrink your investment’s out-of-pocket costs dramatically.
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Introduction to the Unconventional Investor Podcast
Welcome to the Unconventional Investor Podcast. I'm your host, Michelle Moses, certified financial planner, licensed realtor, and founder of Me Financial. If you're an accredited investor feeling overwhelmed by managing your portfolio and looking for alternative investment strategies that go beyond the traditional stock market, you're in the right place.
Let's head into today's episode so you can start taking control of your financial future. Hello everyone and thank you so much for listening.
Meet Brad Updike from Mick Law
I am very excited about this 'cause today we have Brad Updike from Mick Law and I know that a lot of you probably don't know about Mick Law, but when you are in the world of alternatives and you're going to, all these conferences and talking to all the different people about what their investment.
Are they often say, oh, we have a M report. Oh, we have a Mick report. And so Mick Law is very well known in the alternative asset space, and Brad is often piping up and understands the, just all the fees and the backwards and forwards of everything, of all of these. So I am very excited to have you on.
Thank you so much for taking the time, Brad. You're welcome. So Brad, and I'm gonna read his bio and it is probably the longest bio that I have had, but I'm going to read it because it is so impressive to me. So Brad's areas of focus include structuring, underwriting and due diligence of private placements, including oil and gas.
Real estate, private equity, and structured finance. He has reviewed hundreds of sponsor companies in approximately 800 unique private placement offer offerings for various clients. He has also provided income tax consulting and underwriting support on non-traded investment program strategies involving 10 31 like kind exchanges, life settlements.
DSTs, qualified opportunity zones, renewable energy products, conservation, e easements, and private placement life insurance. So thank you again for being on Brad. Absolutely. Good to be here.
Understanding Oil and Gas Investments
So today we're gonna be talking about oil and gas specifically you guys. And I told Brad before we got started, I have 'em on for my own benefit too, because I have read quite a few of these.
But they are very complicated. It's a very popular, area to invest in basically, mostly because of the tax benefits. And I think now we have this big push to become energy independent and I, whenever there is a crisis, we all kind of wanna be energy independent. So I do think that there's a push on this.
But the oil and gas. Funds are structured differently and they are hard to understand. And so I'm hoping to get a little bit of clarity in this podcast. So let's go ahead and get started, Brad. And so can you, let's give an overview of oil and gas and can you tell us like why people normally invest in oil and gas and what the benefits are to it?
It's the seventh largest economic industry in the world. And I think it's important to point out that the top six industries actually depend on it as their source of power. If you actually look at the s and p 500 ENP returns, exploration and production returns in 23 and 24, they were both indexes grew by more than 20%.
I think with that. Smart investors and advisors naturally want some exposure to this asset class.
Investment Avenues in Oil and Gas
But that said, there are two main investment avenues for oil and gas for investors that want exposure to it, but they require liquidity and they have maybe a low. To medium risk tolerance, I think you're gonna look at the publicly traded companies and their securities.
That's your eqt, Diamondbacks, Exxon Range Resources, Devon Comstock Resources in the world. And on that point, if you're objective. Is income. I think you're gonna look at bonds, but if your objective is some income maybe, and a lot of upside, I think you're gonna look at maybe the common stock offerings of these companies.
And just a side note on that, for those that invest in the common stock of these publicly traded companies, they get a pretty nice tax benefit in the fact that when they get dividends, those are actually taxed at capital gains rates as opposed to ordinary income. You're second. Investment avenue is the non-traded security sector.
That's where I live. And this sector includes oil and gas investment programs that are sold by broker dealers to retail investments. To retail investors. These are structured as private placements. In some cases. They also include S one offerings and reg A offerings.
Tax Benefits of Oil and Gas Investments
In the private sector, the products are sold to investors that are often looking for income tax advantages, and they're willing to maybe sacrifice that liquidity that you would otherwise get.
From a public investment in order to secure that tax benefit as the most common form of private investing for re the retail channel. I think many retail investors are looking at the drilling programs where they can accelerate 100% of their allocated intangible drilling costs. That's also referred to as IDCs.
If certain tax requirements are met and the IDC deduction in these drilling programs can be pretty significant. It's about 65 to 80% of that investor subscription. What that does, that's actually lowering the tax effective cost to that investment from perhaps maybe a hundred thousand dollars. If your investor submitted a subscription for that, it actually lowers it to maybe 65 to 70.
Thousand dollars. So yeah, that helps the return the tax from a tax effective standpoint. Some other good tax notable tax deductions that you often get in these retail drilling programs, the tangible equipment deductions, those are also allocated to the investors. Generally is about 10 to 20% of the subscription.
And you generally get about 40% of that in the year that the equipment is placed in service under the actual, the bonus depreciation rules. So yeah, the tangible equipment layered on with the IDC, it actually lowers that effective cost of the investment pretty significantly. Another thing, and I think this is perhaps maybe the most important.
Benefit is the percentage depletion deductions, and basically what you're getting to do, the investors are actually getting to take they get 15% off of their gross oil and gas production income. That's pretty significant. And you get that actually regardless of where your cost basis is.
So you could actually. You could bring your cost basis like down to zero, but you still get that percentage depletion every year. So that's pretty significant in addition to the income tax features. Another key component of the benefit is the outsized returns. If you're underwriting this correctly your goal in terms of return, you're gonna want something that's significantly above what a high yield, public investment would bring you. And for drilling programs, when we underwrite these, I'd say our general expectations for drilling programs, we wanna see the investor have an opportunity to achieve an IRR. In the neighborhood of 15 to 30% and a return of capital four to five years.
Royalty program's a little bit different. Our general expectations for royalty programs about an eight to 15%. IRR. Can you explain what a royalty program is? Just real quick. A royalty program is where you're act, you're not acquiring a working interest in the lease, you're actually acquiring the mineral rights and the royalties associated with that.
I think I should probably go back. To the oil and gas lease in a drilling program. What the program is actually buying is a working interest, and that's basically the the less, the lessee of an oil and gas. They're actually leasing the drilling rights from the mineral interest owner. In cons, what they get is they get the ability to drill on the property and then what the actual mineral rights owner gets, with the mineral interest, you, they could actually drill it themselves. But 99.9% of the mineral interest owners in America, they don't really have that wherewithal. So what they do is they lease their drilling rights to these oil and gas companies and what they get. In exchange for that, they get a lease bonus and then they also get a type of a rent that's called a royalty, and it's a percentage of the production.
And it's actually they don't have to share the burden of the lease operating costs. They do pay some of the production taxes and some of the costs to move the oil and gas, but they don't have to pay lease operating costs. Costs. They don't pay drilling costs, which is very expensive. All of this, you guys is very expensive, not royalty.
That rent. Yeah. That's coming to them free of yeah. The CapEx. That's normally associated. So do you normally see funds that are with there's just drill? Do they combine them? Because I, what I have seen is, okay, we're selling mineral rights and they just have mineral rights, and then there is the working interest.
In it and and then there's equipment. And so there's the different ways to invest in, and I've seen them separated out. But do you see them all combined also? Never. Actually. The two basic types of oil and gas investment programs. I talked about drilling programs a little bit. They're basic.
That's where the program is. Taking money. They're raising money from retail investors and they're using that to acquire working interests in oil and gas wells that are going to get drilled. The second type of investment program that would be. Those that actually acquire mineral rights and royalties, they're taking the other side of the oil and gas lease.
They're buying interests in which they're going to be receiving the rents, the royalties as that oil and gas is produced. As far as the drilling programs go in terms of structure, they're all structured as limited partnerships generally under Texas or Delaware law, but they have this special feature, it's called the GP LP election, in which the investor, that retail investor, they can decide whether or not they want to participate in that drilling program as either a general partner or a limited partner.
And often they make that decision just depending on their sources of income. So the way that works, if I was a doctor lawyer. Or just another professional with a lot of like wages, W2 wages, active income. I'm gonna make a gp general partner election, and that's gonna give me the ability to actually take that IDC and all of the allocated deductions, and I can use that to offset my active income.
On the other hand, maybe if I was a senior citizen with a lot of passive income, maybe I make that limited partner election, which I can then use the IDs. CS I can use like the other allocated deductions to shelter my passive income. Just continuing with drilling programs. Some have the ability to specially allocate the offering costs and the intangible drilling costs maximize that investor first year deductions.
So in cases where we have a sponsor that actually puts in a lot of their own capital into these deals, what that allows, the program to do is to specially allocate the offering costs and the leasehold costs to the sponsor, whereas the investors are actually going to get specially allocated the IDCs intangibles, which actually drive up that first year deduction.
And so do you see that? So it drives up the, what'd you say that drives up the first year reduction. First year reduction. Okay. Because IDC, if you meet certain tax requirements to accrue that deduction you're allowed to actually deduct your IDCs, your eligible share of the IDCs in the year of investment.
Yeah. 'cause that's what I see is that people invest, it's almost like an addiction. They invest in oil and gas, and then they get, like 80% write off, let's say if everything adds up. And then the next year they want the same thing, and so it's that's what I call it almost it's almost like a tax addiction as they're investing so that they can get that tax write off.
Which isn't a bad thing. I'm just, it's, no, it's not a bad thing. A funny way that I put it. It lowers the tax effective cost of the investment, but still you have to have the true non-tax economics to make it work because these tax benefits in these programs, although they're very nice and they're competitive compared to other alternative investments.
Yeah, it's not gonna first. Get you home, make you whole. So you really also have to look at the quality of the operator. You gotta look at oh yeah, the quality of the areas that they're drilling. And you have to actually run the numbers, do a reserve report in an effort to determine, under realistic conditions, can I get.
Like a non-tax adjusted IRR of that 15, 20, 20 5% on my money. And so and you touched on something about looking at the operator. How do you know, 'cause there are the, the oil and gas industry is very big and there are, it, there's a just a lot of details, right? Because you guys I think you need to understand like when you're getting your reports, it's literally like this on this.
Little track of land and it's really complicated when you're getting your income reports. So Brad, is there a way to review, I know you guys have your due diligence reports, but is there a way that you would recommend of looking at operators that it would make it a safe investment? Is it time in, reading your reports?
Are there other things that we could be looking at?
Evaluating Oil and Gas Operators
Yeah, we're looking at the financial wherewithal of the operator. We're looking at a lot of things. First of all, we wanna make sure. That this is an operating that's well capitalized. They have the wherewithal to actually drill and to manage the fund 15, 20, 25 years into the future.
The problem is sometimes, like some of these programs come out, you get these sponsor operators that just have to raise that money, that slug of money to stay in business, and that's not what you want. So I think financial statement analysis is critical. From a sponsor level perspective, you're gonna look at the current ratio and liquidity.
You wanna make sure that this is a company, that it's not gonna go out of business if maybe they don't raise maximum amount of capital that they're looking for. You're gonna look at debt to equity ratios. You're gonna actually call the bankers. You're gonna make sure that the loan covenants.
On, on the loan, if there is one that they're following them, you're gonna look to debt, to earnings. You're also gonna look at prior performance. You're gonna want to take a look at the sponsor's, operator's, track record, just to see like how well they have. Done in projects in the field that money is being deployed.
I think that's also important, from a sponsor perspective. 'cause in a lot of cases, we've dealt with sponsors where maybe they've established a good track record in one basin, but because of economics, because oil and gas prices move the way they do, maybe they're at least positioned in a certain area, is becoming uneconomic.
Or it's not as good from a return perspective. So maybe they try to allocate capital and they get a position in a basement that they don't understand, how to operate. So yeah, that's something that we also have to take a look at. Yeah. Yeah. When an operator style drifting, when they're going outside of their basin of competence, core competence that can be actually problematic.
And in most cases it is. And then also I think you wanted. Look at sponsors. You wanna do business with sponsors that have optionality, that actually are so well capitalized, that they have the ability to maybe drill when prices are good and to keep production at high levels or low levels when prices move.
They're not maybe beholden to have to drill all the time and to be a price taker. These are like companies that are actually price makers, not price takers. That's a great, that is a wonderful point. Yeah, because it have the ability for It goes up and down. Yeah. Yeah. Oil goes to 40 or 50, they don't have to just keep drill, baby drill.
They. Keep the production on, they actually have the financial wherewithal maybe to shut down that production a little bit or to cut it back, to choke it back in order to maybe preserve some of the economics for the investor down the road. Yeah. And you guys, it's and I think what goes into that, if you haven't looked into oil and gas is it is really expensive to drill in certain places and not in others.
And it, it's. So when the price of oil is going up and down, it makes it feasible to drill, let's say up north in the winter, where you're having to put in something out in the middle of nowhere. They have to create these huge cities. It takes a lot of capital to do that.
And and so when the price of oil is low, it doesn't make sense to drill there. So that's. Basically what we're talking about. And so we, you wanna make sure that they have the ability to not drill and still make money because of the drills that they have already done in the past. And most of the time, Brad, tell me if I'm wrong, the ones that are cheaper are mostly in like Oklahoma and Texas.
It's just. The structure, the infrastructure is there it's easily accessible and is therefore cheaper to drill. And you're not having to set up whole cities in the middle of nowhere of North Dakota. So can we touch on something for because years ago I was really into mineral rights and you don't see that as much as in investments and mineral rights are more like owning the rights of the land and whatever is beneath it.
Do you find that is like a safer investment for people to go into? Or does it just depend on their situation? I think it depends on their situation. Yeah. I think it's just a different. They, it is a different investment. It's got different tax features, for example just talking about the tax benefits that are associated with royalties, mineral rights, a lot of.
The, these investments are actually considered real estate under state law. So if you buy into a a royalty or mineral rights acquisition program, you can actually use it as replacement property for a 10 31 like kind exchange. If that program's actually structured as one where the investors actually have like direct title or a fractional interest in the in the asset.
Which I think is a wonderful asset to also, yeah. Yeah, royalties, mineral rights, it's a passive investment. Just a different tax objective. Like for drilling programs, those tend to be sold to professionals, lawyers, doctors, with W2 active income, whereas when you're looking for investors for mineral rights and royalties.
They don't necessarily need that high IDC right off to maybe offset a bunch of active income, but they're looking for maybe a tax preferred source of income down the road where the depletion allowance is gonna help them actually from an income. From an income efficiency perspective, and then also again the direct title royalty programs are actually 10 31 eligible, so well, so would that protect you from the company going under if you owned the mineral rights versus if you were in an IDC?
That is correct. Yeah. You own the mineral rights and the royalties, so it's a perpetual, yeah. So it would, you're not so dependent on the sponsor that you're investing in because you actually own the mineral rights for mineral rights. We do look at the under underlying operators that are actually drilling the wells with within those, mineral acreage areas. I think that's important. So yeah, you do wanna look at the quality of the operators and you wanna make sure that yeah, you're well diversified in terms of operator account. But yes the mineral rights and royalty programs, they're unleveraged they're not using debt. And yeah, you generally have the wherewithal to basically maintain your investment if.
Oil and gas prices go low. Okay. And so what are, and I think this is a good segue, so what are some of the biggest risks that investors should be aware of in the oil and gas private placements? Biggest risks, I think, again, thinly capitalized operators. We've seen a lot of these program blowouts occur when we have an operator that just.
Had to raise the maximum amount in order to stay in business, and that's really problematic. I know that the private placement markets, it's created this kind of startup, capital venture capital. But yeah, when you're selling to retail investors, I don't think necessarily that general rule holds true.
You're really wanting to look at operators and programs that are maybe better in comparison to maybe, you know what? What type of quality or risk, you're getting well, and a lot of that comes with time if they've got the capital right. That it comes with time of being able to have the capital in order to do all of this.
And it, it has been astounding and shocking to me. The amount of capital that drilling takes it is really mind blowing. Yeah, you wanna definitely do business with a tier one operator. Good balance sheet, good liquidity again. You also have to make sure that this operator has a relevant prior performance in the area where money is being deployed again.
We've seen operators that have done well in, in prior like deals, but yeah, they get into a situation where oil and gas prices move and then their inventories are un economics, so they just. Move everything over to a new field, a new base, and then they just don't understand the operational characteristics and requirements of that.
And that also could go bad, just as bad as the first scenario that I just explained. And then also, I think optionality, doing business with a new bird and MDS or US Energy, that actually has a pretty strong balance sheet that's. Important too because yeah, you want to do business again with these companies that just don't have to drill baby drill, that don't have to be producing at 100% rate in order to stay in business companies that have optionality to be able to cut back their production, to cut back their activities, and to time it based on, where based on the price.
Yeah. Okay.
Current Trends in Oil and Gas
And where do you see the current trends of oil and gas and where things are going? Oh, as far as like market fundamentals we've got a really interesting I think situation here. You've got different levels of optimism in oil and gas. I think oil, you could say that again, a little bit of a bull market here.
You've got the tariffs, you've got the trade war, and there. I guess a natural obvious sentiment that's gonna lower demand worldwide. If you look at the energy information administration's forecasts, I guess they're forecasting oil for this year to be about 64, 60 $5. I guess on the WTI and then actually if you look at their forecast for next year, it's actually about 60 59 60.
So yeah, you've got some bullish sentiment on the oil side, whereas natural gas is a little bit different story. I think you've got really good market fundamentals. 'cause there's a s. That. Yeah. This is Trump's darling. He wants to increase LNG exporting substantially. There's also data center construction going in in order to support the AI movement, which is gonna require natural gas.
So there's a real, a real good argument. That demand in natural gas is gonna go up about 2025, perhaps 30% over the next four to five years, which is why you're seeing actually a little bit different. Optimism and then natural gas markets. The EIA for this year, I guess they're predicting. $4 and 30 cents in MCF, which is about probably 35% higher than what they were predicting last year.
Wow. Wow. That's good. And you guys natural even for, yeah, for 26, they're almost close to $5 in MC. Oh wow. Four 60. So yeah. I hope it holds through well. Yeah. And you guys, natural gas is a natural byproduct when they're drilling, so they they come out together just so that, I think that's also a good due diligence point.
Yeah. Are you like. I think you also maybe want to take a closer look at the sponsors, the operators that are actually drilling both oil and gas and liquids and that actually have that diversification of commodity mix. And there's some good companies out there that are doing that. Like Bert for example, they're in the Permian base and where you get a mix of oil, gas, and liquids.
Also, Waveland resource partners. Number seven. That's a non-traded type of hedge fund. They're buying a lot of like non-operated working interests in operators projects in the bachan, and they're exposed also to oil and natural gas and liquids. So they've got that going for 'em. Yeah. Oh, I, and I agree.
Being able to pivot, especially like with what happened however many years ago, was that 10 years ago, 15 years ago? Yeah. So there were a lot of operators that went outta business and I think being able to pivot and go into different products is important.
Conclusion and Final Thoughts
And I. I know that you guys, this podcast is not gonna help you be like, okay, I know exactly what I'm doing.
But the more that you listen to this and read it, you are going to start to understand some of what is going on in oil and gas. And then I've had some people feel bad about investing just because the electric cars and, we have all. Things. And I think what has happened is that we realize we need all the energy, we need the solar and the wind and the, we need clean nuclear and we need oil and gas.
It's, there isn't going to be one single answer that is going to, solve all of our energy needs. I think we've realized that these batteries in the cars are not as great as what we thought they were and, to get all the minerals out of the earth. And so I'm really trying to highlight all the different energies that are out there.
And I think oil and gas is already established. We already, know what we're doing and we have a ton of it in the ground. And so I think, it's important to take a look at it. Yeah, I think that, yeah, it's gonna take all of that. It is. It's, and especially with AI and data centers and, yeah.
Those types of things it is gonna take more and more energy. Brad, I really appreciate you taking the time to be on here. And I am going to your conference here in a couple months, or no, next month. It is in a few weeks. And you guys, thank you for listening. I hope that you learned a little bit about oil and gas and what some of the private placements offer and the tax advantages that they offer.
And again, Brad, thanks so much for being on. Thank you. Okay, everybody, have a great day and thanks for listening. Thank you for listening to The Unconventional Investor Podcast. I hope you feel more confident in how you can grow your wealth using the strategies I shared in this episode. If you're ready to take the next step in diversifying your portfolio outside the stock market with alternative investments, head to me financial.net/contact us to book a 15 minute consult call with me.
Let's discuss how we can work together to achieve your financial goals. Until then, I'll see you on the next episode.
Disclaimer: The information provided in this podcast is for general informational purposes only and should not be construed as professional financial advice. Always consult with a qualified financial advisor or professional before making any financial decisions. The hosts and guests of this podcast are not responsible for any actions taken based on the information presented.