7859 / What are the basic types of oil and gas drilling programs?

In exploratory drilling programs, wells are drilled far from areas of proven production or, at best, on the periphery of a proven field. As a result, the likelihood of drilling successful wells (versus “dryholes”) is reduced and the risk that little or no return on invested capital will be realized is increased. In addition, because exploratory wells are often drilled in remote locations, the drilling and marketing costs are likely to be higher. On the other hand, the return on investment in the case of successful exploratory programs is generally much greater than on successful development or income programs.

In development drilling programs, wells are drilled in proven areas. Thus, development programs are less risky than exploratory programs, but because the costs of acquiring drilling rights in a proven area are greater than in an unproven (exploratory) area, the return on investment is likely to be less also.

An income purchase program purchases the reserves of proven wells that have already been drilled. As a result, income programs involve the least investment risk. (Previously, income programs were generally not considered to be “tax shelters” because deductions for percentage depletion and intangible drilling and development costs were generally not available. However, percentage depletion may now be available to those who participate in these programs (see Q 7866, Q 7874).)

Combination drilling programs combine the exploratory, development, and income type activities into a single, diversified program. Although the major reason for utilizing a combination program is to offer investors a reduced risk of loss of capital, public programs tend to emphasize exploratory drilling within the combination and participate in income purchase activities to only a very small extent.