Reuters Money

There will be tax breaks: Investing in oil and gas drilling

Seated in the conference room of his wealth management firm in San Ramon, Calif., Rich Arzaga breaks out a few tools to explain the investment advantages of oil and gas drilling programs. He’s got a fine-point pen and a sketch pad — but alas, no milkshake a la Daniel Day-Lewis in “There Will Be Blood.”

“This is not wildcatting,” says Arzaga, founder and CEO of Cornerstone Wealth Management and an adjunct professor in personal finance at the University of California at Berkeley. Lewis’ anti-hero in “Blood” swindles and snakes for oil wherever he can find it, whereas Arzaga (pictured) wants to discuss something much more civilized: qualified drilling programs that yield big tax savings for investors and, if you’re lucky, 10 or more years of financial returns.

Still, if that sounds a little bit Hollywood, Arzaga understands. “Insurance companies, wire houses and banks don’t offer this type of alternative investment,” he says. “It’s not their thing. You have to hang out with the independent advisers who do this.” You also need at least $25,000 to start, which explains why over the last five years, Arzaga has been limited to roughly a dozen clients in this realm.

Yet at a time when Wall Street sports the stability of a rickety roller coaster, and European turmoil dogs investors on North American shores, oil and gas drilling represents a niche so far outside the norm that it’s in many respects immune to common economic doldrums. And when oil prices soar, the prospects for this commodity look downright appealing— that is, up to a point. To be sure, once you give your cash over to the program, it stays there until the wells pan out, or don’t — making it much unlike a liquid mutual fund, for example. This explains in part why the program works best for those trying to avoid a major tax hit on an appreciated asset, where the burden might be 40 percent.

What’s more, “The number one risk is that there’s a certain amount of fraud out there,” says Grant Rawdin, president of Wescott Financial in Philadelphia. Yet once you find a drilling company with a solid reputation — Arzaga, like many in the game, uses Atlas Energy — you don’t just sit back and wait for the black gold to pour in.

“Then you have to do your homework,” Rawdin says. “You need to look at geological surveys, how other wells have done, what the drilling costs are going to be. And once that oil well goes dry, you’re done, so you have to amortize your investment over the life of the well.”

In the typical program, an investor immediately yields tax breaks as sanctioned by IRS codes, which are now more than three decades old. With a highly appreciated asset, you can put the money into oil and gas drilling and shelter it almost entirely from capital gains tax. If you invest $1 million and are in a 40 percent tax bracket, you will save about $350,000 right off the bat, Arzaga says. (The sheltering comes from how the program is structured; federal laws allow typically for 89-91 percent of the investment to be allocated to intangible drilling costs that can be written off entirely in year one.)

Are commodities too risky for individual investors?

The commodities sector offered one of the best storylines in recent years:  strong growth thanks to increased demand from emerging markets, an opportunity to hedge against inflation, along with all-important portfolio diversification. Until the recent selloff, silver was the best-performing commodity in 2011, nearing all-time highs of $50-per ounce.

But as silver plunged 30 percent in the last two weeks, and oil, cotton, gold and other commodities prices have similarly been battered, investors seem to be spooked by the volatility. Case in point: the world’s largest silver-backed exchange-traded fund,  iShares Silver Trust, has seen massive outflows.

With so much churn, do mom and pop investors belong in commodities? Although they are often targeted to individual investors because they are so easy to buy and sell, exchange-traded funds (ETFs) that focus on commodities are especially popular with professionals, such as hedge funds, who thrive on volatility. Professional investors have the resources to closely monitor every move of the ever-changing commodities market — but most individuals might not have the time or tools to stay on top of the long list of factors that impact commodities prices, including the futures market, political events, economic data and even the weather. That’s why experts suggest keeping commodities exposure to no more than five percent of your overall portfolio.

Tell us what you think.

Are commodities too risky for individual investors?

• Yes, they pose too much risk
• No, they provide a great investment opportunity

Prius envy: Revenge of the hybrid driver

Jade Boyd lives in the People’s Republic of Pickup Trucks. As a science editor for Rice University in Houston, he’s literally surrounded on the road by Ford F-150s and Chevy Silverados. “I grew up in Texas, my dad always had a pickup, and if I had my druthers, I’d have a pickup too,” says the married father of two. “The Texan in me would love to drive a truck every single day.”

But then there’s the little issue of gas costs. With his friends filling up their pickups at around $75 a pop, twice a week, that’s $600 a month disappearing right into the tank. That’s why in 2007, Boyd went against his natural Texan instincts and bought himself a hybrid Toyota Prius.

Now with Libya in virtual civil war, the rest of the Mideast bubbling with unrest, and gas prices going through the roof, Boyd feels pretty prescient. He has a 60-mile work commute every day, but between carpooling and his gas-sipping Prius, he only has to fill up once a week. “For the longest time I couldn’t even put $20 worth of gas in the car,” he says. “It wouldn’t even hold that much.”

Great for him. Not so great for his truck-driving buddies, who are feeling Mideast turmoil right in their wallets. According to the Lundberg Survey of 2,500 gas stations around the country, gas prices just rose 33 cents a gallon in two weeks –- the second-biggest leap in the history of the gasoline market.

That’s why auto experts are now noticing a dramatic turn in car-buying behavior: Call it Prius Envy.

“We’ve seen conclusive evidence of that in the last two weeks,” says Karl Brauer, a senior analyst with auto-information site Edmunds.com. “There’s been a major shift in activity towards compact cars and hybrids, and away from large trucks and SUVs.”

Just take Toyota’s Prius sales numbers for February: 13,539 of the cars were sold last month, compared to 7,968 a year earlier. That’s a 70 percent year-over-year jump. When you look at average gas costs, it’s not difficult to figure out why. At 51 miles per gallon, Prius owners pay an average of $900 per year for fuel, while someone driving a 25-mpg car forks out more than double that, at $2,100.