Evaluation of Oil Properties in After-Tax Dollars

Abstract

Abstract Why do we talk about "pre-tax dollars" and "after-tax dollars"? In choosing its investments, management today usually asks the question, "How soon will we have a full return of our investment after all income taxes?" Contrary to our intentions, every business venture that we enter into today has some unseen "net profits interests" who get a major percentage of our net profits but stand none of our net losses if the venture is unsuccessful. This refers, of course, to the fact that, under the present rates of income taxes, the United States Government and the State of California (or some other state) get approximately 50 per cent of the net profits (if any) of any venture of a large corporation and varying percentages in the cases of small corporations, partnerships and individuals. Field property valuations are ordinarily submitted on a strictly engineering basis, arriving at the present worth of the net cash recovery before income taxes for the estimated life of the property. To convert these pre-tax dollars to the after-tax dollars so often wanted by management in weighing one proposed investment against another, it is necessary to estimate the income taxes payable by years. In an extractive industry such as ours, statutory depletion is an important element in this computation, as are the depreciation deduction and method of financing also. These computations are ordinarily done by accountants versed in income taxes. This paper is presented to explain how accountants and petroleum engineers must sometimes work together to get the final solution desired in making a valuation of oil and gas properties in after-tax dollars. Introduction Income taxes have reached such high rates that all important business transactions made today are entered into only after consideration has been given to the impact of income taxes on the final net results. Most agreements are drawn in such a manner as to minimize income and other taxes as much as possible and avoid the payment of any unnecessary taxes.