Cypress Drilling-Glossary

ACCREDITED INVESTOR

A person or institution deemed capable of understanding and affording the financial risks associated with the acquisition of unregistered securities. The SEC recognizes the following parties as accredited:

• An individual who alone, or with a spouse, has a net worth of over $1 million.

• An individual who alone had income in excess of $200,000 in each of the past two years (or with a spouse, in excess of $300,000 in each of the past two years) and has a reasonable expectation of doing as well in the current year.

• A financial institution such as bank, broker/dealer, insurance company or business development company.

• Any director, officer or general partner of the issuer.

• A trust or business partnership, with assets in excess of $5 million, that wasn't formed for the purpose of acquiring the unregistered securities.

• Any entity wholly owned by accredited investors.

ACIDIZING

A technique for increasing the flow of oil and/or gas into a well. Hydrochloric acid is pumped into the oil-bearing rock. The acid dissolves limestone in the producing zone enlarging pores and flow into the well bore with less restrictions.

BARREL OF OIL

42 U.S. gallons of oil at 60 degrees Fahrenheit.

BIT

A bit is the drilling tool that bores or cuts into the earth. There are two basic types: the cable tool bit which moves up and down the hole, striking the bottom, chipping away the rock, and the rotary bit which revolves to grind the rock. The rotary is the modern technique used in most drilling operations.

BLOWOUT

An unexpected violent eruption of oil and gas from a well during the drilling phase of operation. This happens when high pressure gas is encountered and the proper precautions have not been taken. The initial eruption is followed by an uncontrolled flow of fluids from the well.

BLOWOUT PREVENTER

A "BOP" is a large, specially designed valve that is mounted on top of the well during the drilling and completion stages of operation. The operator can close this valve to stop the flow of oil or gas in case of emergency.

BOTTOM HOLE PRESSURE

The reservoir pressure at the bottom of the well. When the well is flowed, a decline in pressure occurs. The amount of decline in pressure related to the amount of oil production will give an engineer information regarding the reserves of the well.

C&E

Well completion and equipment cost.

CASING

Steel pipe which screws together and is lowered into the hole after drilling is complete. It is used to seal off fluids and keeps the hole from caving in.

CASING POINT

When the well has been drilled to its objective depth, the operator is faced with a very important decision, whether to commit additional dollars to "setting pipe" and attempt a completion or to abandon the well as non-commercial. The success or failure of many companies has been dependent on these decisions.

CEMENT OR "SET PIPE"

A process whereby cement is pumped into the hole between the walls of the hole and the outside of the casing. Upon hardening, the cement holds the pipe in place and prevents fluid movement in the hole.

COMMERCIAL WELL

A well which is capable of producing enough products to pay for itself and give a profit to its owners.

COMPLETION

A general term referring to all activities necessary to put a well on production after it has been drilled to casing point.

CRUDE OIL

Oil in its natural state of composition. "Crude" is classified according to its physical properties: a. Paraffin Based, b. Asphaltic Based, c. Mixed Based.

CUTTING OR SAMPLES

Pieces of rock cut out of the formation by the bit and circulated to the surface by the mud. Geologists study this rock for signs of oil and gas as the well is drilled.

DEPLETION

The reduction in value of mineral deposits as it is produced. Oil is a wasting asset, in that proceeds from the well represent both income and return of capital.

DEPLETION ALLOWANCE

An allowance granted on taxable income from oil and gas by the Federal and most State Governments. The current Federal rate is 15% of gross income. The law is rather involved and a tax specialist should be used when computing the tax free portion of income. This information is supplied to each partner prior to filing his income tax returns on April 15th of each year.

DEPOSIT

An accumulation of oil, gas or other minerals which is capable of production.

DEVELOPMENTAL WELL

A well drilled to a known producing formation in an existing oil field.

DISCOVERY WELL

An exploratory well which encounters production in a previously unknown deposit.

DIVISION ORDER

A contract with a purchaser of oil and gas which directs the payments of oil and gas revenues to the interest owners of a well.

DRILLING

The act of boring into the earth.

DRILLING RIG

The equipment used to bore into the earth. There are two types: a. Rotary b. Cable tools. The rotary type is more modern and efficient.

D&A

Dry and abandoned.

D&T

Drilling and well test cost.

ELECTRIC LOG

An electrical survey made on uncased holes. A special tool is lowered into the hole which ejects an electrical current into the rock and records its resistance to the current. The data from the survey is used by the geologist to determine the nature of the rock and its contents.

EXPLORATION

A general term referring to all efforts made in the search for new deposits of oil and gas.

FLOWING WELL

A well capable of producing oil or gas by its own energy without the aid of a mechanical pump. Normally a pump is put on the well after the pressure reduction inhibits the rate of production.

FRACING

The process of pumping fluids into a productive formation at high rates of injection to hydraulically break the rock. The "fractures" which are created in the rock act as flow channels for the oil and gas to the well.

GAS WELL

A well that produces natural gas which is not associated with crude oil.

IDC

(Intangible Drilling Costs) All cost incurred in drilling a well other than equipment or leasehold. These expenses are 100% tax deductible even if the well is productive.

(Initial Production) Production from a well is generally broken down into three categories: a. Flush or Initial b. Settled c. Stripper. It is important for investors to realize that a well cannot maintain the flow rates it made during the first stages of its life.

LIMITED LIABILITY

Entities limiting liablitity

If a taxpayer holds his working interest through any of the following entitees, the entity is considered to limit his liability, and the taxpayer's interest in the activity will not be exempt from the passive loss rules

1. A limited partnership interest is a partnership in which the taxpayer is not a general partner.

2. Stock in a corporation.

3. Any entity other than a limited partnership or corporation that, under applicable state law, limits the potential liability of a holder of such interests for all obligations of the entity to a determinable fixed amount. (e.g., the taxpayer's capital contributions).

NON-COMMERCIAL

A well that is not capable of producing enough oil to pay for the drilling.

NRI

(Net Revenue Interest) That percent of the production revenue allocated to the working interest after first deducting proceeds allocated to royalty and overriding interest.

OIL

A liquid hydrocarbon. (see "Crude Oil")

OIL GRAVITY

The most widely used indicator of a crude oil's worth to the producer is its API gravity. Normally, the price which a producer receives for his oil depends on its gravity, the less dense oils (higher API gravity) being the most valuable. This price schedule is based on the premise that the lighter oil contains higher percentages of the more valuable products such as gasoline. API Gravity (degrees) = (141.5/sp.gr.) - 131.5.

OIL & GAS LEASES

A contract between an oil operator and a landowner which gives the operator the right to drill for oil and gas on his property for a consideration. It is simply a "ticket to hunt".

ON THE PUMP

An expression that means a well is incapable of flowing and that the oil is being pumped to the surface by a "pumping unit".

OPERATING EXPENSE

The expenses incurred through the operation of producing properties.

PAYOUT

When the costs of drilling, producing and operating have been recouped from the sale of products on a well.

PERMEABILITY

A measure of the resistance of rock to the movement of fluids. Rocks may have holes or void spaces in them (porosity), but if these holes do not connect, the permeability can be drastically reduced.

POROSITY

A measure of the relative volume of void space in rock to the total rock volume. These spaces or pores are where oil and gas accumulate; therefore, a formation containing a high percentage of porosity can contain more hydrocarbons.

PROVEN RESERVES

Oil and gas which has not been produced but has been located and is recoverable.

PUMPER

An employee of an operator who is responsible for gauging the oil and gas sold off the leases he has been assigned and who is also responsible for maintaining and reporting the daily production.

REAL ESTATE INVESTMENT TRUSTS (REITs)

A trust or association that invests in a variety of real estate. REITs are managed by one or more trustees, like a mutual fund, and trade like a stock. No federal income tax needs to be paid by the trust if 75% of the income is real-estate related and 95% of the income is distributed to investors. Individual investors can be taxed.

REWORK OPERATIONS

Any major operation performed on a well after its completion in an attempt to restore or improve its ability to produce.

SALT WATER DISPOSAL WELL

Many wells produce salt water while producing oil. The disposal of this water is a problem to an operator because of pollution. The best solution to the problem is to pump the waste back into a formation that is deep enough not to pollute shallow water sands. Many stripper wells which are no longer commercial are converted for this purpose.

SECONDARY RECOVERY

A broad term encompassing any method of extracting oil from a reservoir after a well or field has exhausted its primary production.

SEDIMENTARY ROCKS

Rock is generally classified in one of three categories: a. Sedimentary; b. Igneous; c. Metamorphic.

SETTLED PRODUCTION

The second phase of production in the producing life of a well. (see IP).

STRIPPER WELL

The final state in the life of a producing well.

STRUCTURAL TRAP

A fold or break (or both) in the earth's crust which creates an impervious trap for oil and gas. Oil will migrate underground through rock until it is "trapped".

SURFACE PIPE

Pipe which is set with cement through the shallow water sands to avoid polluting the water and keep the sand from caving in while drilling a well.

SWAB

A tool which is lowered down the pipe on a wire line. The "swab" is then pulled out of the hole. As it travels up the pipe, rubber elements expand so that the fluid in the pipe is trapped above the swab and pushed to the surface. This operation is necessary when the formation pressure is not high enough to blow the fluids in the pipe to the surface.

TANK BATTERY

A group of tanks at a well site used to store oil prior to sale to a pipeline company.

TESTING

When each new well is competed, a series of tests are run on the well. The various tests are used to estimate the daily deliverability, payout, and reserves.

TUBING

Small diameter pipe which is installed in the casing. Oil is produced through tubing because it increases the viscosity of fluid and a well's flow capabilities.

TURNKEY CONTRACT

A contract in which an operator or drilling contractor agrees to furnish all labor and materials necessary to drill a well to a certain depth or stage of completion for a specified sum of money. The operator or contractor assumes all of the responsibility and risks involved in completing the operation.

VISCOSITY

The resistance of fluid to flow. A high viscosity fluid will not flow as easily as a low viscosity fluid (Mud will not move as easily as water).

WATER FLOODING

A secondary recovery method for the production of oil from a formation. Oil will float on water. When water is injected into some formations, the oil will float or be washed to the surface, thereby, increasing the amount of production from a well or field. Some formations will not react to this type of stimulation.

WILDCAT

A well that is drained one or more miles from a proven well.

WORKING INTEREST

Oil and Gas Working Interests.

A working interest in an oil or gas property held by the taxpayer directly or through an entity that does not limit the liability of the taxpayer is not treated as a passive activity, whether or not the taxpayer materially participates in the activity. Thus, an owner of a working interest in oil or gas property is permitted to deduct otherwise allowable losses attributable to the working interest against other income without limitation under the passive loss rule.

A working intertest in an oil or gas property is one that is burdened with the cost of development and operation of the property, such as the responsibility to share expenses of drilling completed or operating oil and gas property, according to working or operating mineral interest in any tract or parcel of land. Rights to overriding royalties, production payments, and the like do not constitute working interests because they are not burdened with the responsibility to share expenses of drilling, completing, or operating oil and gas property. Likewise, contract rights to extract or share in oil and gas, or in the profits from extraction, without liability to share in the costs of production do not constitute working interests. Income from such interests is generally considered to be portfolio income.

A special rule applies in any case where, for a prior tax year, net losses from a working interest in a property were treated by the taxpayer as nonpassive losses by reason of the working interest exception. In such case, any net income realized by the taxapayer from the property (or any substituted basis property) in a subsequent year also is treated as active income. For example, suppose a taxpayer claimes losses with regard to a working interest that starts to generate net income. If he transfers the interest to an S corporation in which he is a shareholder or to a partnership in which he is a limited partner, the income will continue to be nonpassive. The income from that interest may not be offset by other passive activity deductions.

IN GENERAL -- The term "passive activity" shall not include any working interest in any oil or gas property which the taxpayer holds directly or through any entity which does not limit the liability of the taxpayer with respect to such interest.

INCOME IN SUBSEQUENT YEARS -- If any taxpayer has any loss for any taxable year from a working interest in any oil or gas property which is treated as a loss and is not from a passive activity, then any net income such as property (or any property the basis of which is determined in whole or in part by reference to the basis of such property) for any succeeding taxable year shall be treated as income of the taxpayer which is not from a passive activity. If the preceding sentence applies to the net income from any property for any taxable year, any credits allowable under subpart B (other than section 27(a) or D of part IV of subchapter A for such taxable year which are attributable to such property shall be treated as credits not from a passive activity to the extent that the amount of such credits does not exceed the regular tax liability of the taxpayer for the taxable year which is allocable to such net income. You can go to the IRS website for more information.

WRITE-OFFS

That portion of an oil investment which is deductible for tax purposes. All intangibles are deductible.