By Anayat Durrani

In the world of Opportunity Zones, investors tend to be drawn most to real estate, construction and financing businesses. But there are other opportunity zones out there that investors may want to consider, such as those in the oil and gas sectors.

“The majority of OZ funds are real estate focused to where oil and gas or the energy sector in general should in theory have a higher margin pay out, capitalizing on the 10-year hold duration which allows the funds to utilize the volatility of the sector to their advantage,” says Jordan Cramer, financial wealth manager, entrepreneur and CEO of ReVive Qualified Opportunity Zone Fund.

He says if cap gains are deposited in a fund in 2021, “the investor receives 10% knock from the IRS when paying the deferral amount owed in 2026, then after the 10 years is satisfied the investor can sell out of the position for a 100% step up cost basis capturing all the upside and not pay the taxes on the ultimate gains.”

Christopher Cook, director of acquisitions, ELITE Opportunity Fund, an oil and gas opportunity fund, says investors should consider opportunity zones in this sector because location is not a factor in profitability. Since the OZ incentive is a place based incentive, he says any OZ with ongoing oil and gas development and production is a perfect fit for the OZ incentive.

“The economics of any oil and gas activity are completely uncorrelated and unrelated to the adverse business conditions that must exist in an OZ as part of the requirements that had to exist prior to an area being designated as a OZ,” says Cook. “The profitability of energy based OZ investments does not depend on the economic health of the OZ as demand for energy, is inelastic and exists without regard to the geographic source of the energy.”

Another reason to consider the oil and gas sector, says Cook, is because oil and gas rights are real property, which qualifies under the OZ incentive, and oil and gas activities are business activities that are in compliance with the OZ incentive.

“The use of a dual tier, QOF/QOZB structure allows maximum flexibility for the investor as the QOZB pursues the analysis, acquisition, aggregation, development, exploration, production, improvement and drilling (“mining”) of the oil and gas assets all of which are Qualified Opportunity Zone Business Property,” says Cook.

Matthew Iak, executive vice-president of U.S. Energy Development Corporation, told Oil Magazine, that opportunity zone tracts “overlay some of the most prolific oil and gas plays in the U.S.” Following the provisions, he said funds are “allocated for original use, taking lease of the property tract, and developing exploratory wells with no substantial property improvements required.” With these provisions he said OZ funds can “develop strong cash flow in the early years, without waiting on debt financed distributions commonly seen in other types of development projects.” He says any risks could further be reduced “through cross sector matching funds that combine energy and real estate development dollars for a better overall outcome.”

Energy sector an attractive investment for Opportunity Zones

Cook says what makes the oil and gas industry an attractive investment are factors like inflation hedge, growth and superior returns.

“Forty percent of US dollars ever created have been printed in the last 12 months. This massive one year increase in the US dollar supply has implications for asset prices and inflation. Oil and gas gains or maintains value in inflationary environments,” says Cook.

Additionally, he says US oil and gas production is on track for substantial production increases as a result of global shortages of natural gas and crude. He says US natural gas prices have increased by over 300% in the last 12 months and crude prices have more than doubled, and he believes it is a trend that will likely persist due to a switch from coal to natural gas and other alternatives driving demand.

“A significant part of this growing demand for natural gas will be met by the US with much of that located in OZ’s. In Texas alone there are over 628 OZ’s, the vast majority of which have significant oil and gas activity with several Texas OZ’s containing the most intense oil and gas development in the world,” says Cook.

He says OZ’s in the oil and gas sector can yield superior returns since typical oil and gas investment returns are generally multiples of what is common for most OZ investments. “The appreciation and growth potential make them especially well-suited to the OZ incentive,” says Cook.

Inelastic demand also makes OZ’s in the oil and gas sector an attractive investment, Cook says.

“A significant portion of the US daily production of over 11 million barrels of oil per day is presently sourced and from OZ’s. This will only increase as the US consumes over 19 million barrels of oil per day at present,” says Cook.

Then there’s stacked tax incentives. Cook says conducting oil and gas activities in an opportunity zone on Qualified Opportunity Zone Business Property (QOZBP) “allows the investor to access returns that normally would be unattainable in an economically disadvantaged area while at the same time generating tax shielded cash flow that can be reinvested into increasing production as prices continue to appreciate.” He says this activity that would not otherwise be generated in rural bypassed areas where oil and gas production in opportunity zones is common, fulfills the intention and spirit of the OZ tax incentive.

“The compounding effect of the addition of reserves and production combined with the appreciation afforded by expected price inflation maximizes the appreciation of the OZ assets which will not be subject to capital gains after 10 years,” says Cook. “This combination provides the investor with the rare opportunity to protect against the possibility of future adverse tax and economic conditions while providing an extraordinary return.”


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