With oil and gas prices skyrocketing, more and more individuals are looking for opportunities to invest in oil and gas. When evaluating oil and gas investment opportunities, you should know there are two primary methods: the first and most commonly known method is purchasing stock in an oil and gas company; the second is through direct participation programs, which give investors an ownership position in a well and a share of the income it generates. In the case of a stock investor, the returns are reinvested in the company. Direct participation programs, on the other hand, provide investors monthly or quarterly revenue from the cash flow the well generates, giving investors the ability to simply enjoy the supplemental income or reinvest that money in additional projects or other vehicles. Direct participation programs offer investors tax deductions and high income potential; however, it's important to understand the nature of the business, the suitability requirements and the terms associated with these programs. Drilling for oil and gas is a complex business complicated by the fact that many wells that are drilled either do not hit adequate commercial reserves or the well being drilled/completed experiences unexpected problems. The business is further complicated by unscrupulous players confusing the marketplace and burdening investors with the onus of finding trustworthy, credible partners with whom to invest and entrust their hard-earned money. The purpose of this article is to help investors make this distinction.
Due to the inherent risk associated with oil and gas investments, the U.S. Securities and Exchange Commission (SEC) has defined certain suitability standards, which help investors determine whether they are an appropriate candidate for this type of investment. To see if you qualify for an oil and gas investment, go to http://lonestarsecurities.com/questionnaireRJDC.html or call 1.866.859.7827. When it comes to investing in oil and gas, it's important to understand that it's impractical to approach an oil and gas investment as a one-shot deal. You may have to participate in several projects in order to obtain a paying interest in a well. As a result, in evaluating oil and gas investments, consider the fact that the rewards of a successful drilling project may have to make up for losses on both past and future projects that may come up dry or prove to be uneconomical to produce due to inadequate commercial reserves. For this reason, Lone Star Securities has introduced the concept of sponsoring multi-well programs, giving investors a higher probability for success by spreading the investment across multiple wells as opposed to a single-well deal. That being said, there are three key areas to consider when evaluating an oil and gas investment to avoid being burned: the People, the Deal Structure and the Production Projections.
Who Am I Doing Business With?
When oil prices are high, more and more people enter the oil business and start assembling and marketing oil and gas deals. Stay away from fly-by-nights that are looking to make a quick buck off the high price of oil. Look at both the company offering the project as well as the company managing the drilling project. When you're evaluating an oil deal, it's important to be prudent and ask critical questions that will help you differentiate between scrupulous and unscrupulous players. Does the oil company sell its projects through a registered broker-dealer? How long has the company been in business? Do they furnish a track record stating the amount of money invested and net amount of cash received by investors by project? Or, are they only telling you the number of wells drilled and completed? It's important to know that a "completed" well may not mean anything. Many wells are completed but never pay out. Are you able to check the credibility of the oil company, its owner and the broker-dealer representing the company? Who operates the wells and do they have the necessary expertise? How do they structure their deals - is it turnkey or invoice-cost? Who evaluates the geology of the projects? How are projects selected? Any reputable company should be happy to answer these questions. Note that anyone can sell an oil and gas investment whether they're a registered broker-dealer or not; however, you can mitigate your risk by working with a registered broker-dealer and member of the Financial Industry Regulatory Authority (FINRA, formerly known as the NASD) whose representatives are licensed and held to the highest standards of disclosure as defined by the SEC.
You should also ask to speak with existing investors as a reference for how their experience with the company has been. It's important that the company keep investors informed at every stage of drilling and completion. You should receive regular progress reports as well as essential year-end information in a timely manner.
How Is The Project Structured?
There are nearly as many ways to put together an oil and gas investment in a drilling project as there are oil companies in the industry. Regardless of the project's structure or complexity, however, each can be boiled down to two simple questions: What is the anticipated cost to drill and complete the well? And who gets what percent of the revenue over the projected life of the well?
Most private placement oil and gas drilling projects have several parties involved when it comes time to sharing revenues from a producing well, including: the land or mineral owner, the project manager, and the investor group, which is financing the cost of drilling, completing and producing the well. Let's look at these in turn:
Traditionally, the land owner or mineral owner receives between 12.5% to 25% of the total production revenue of a producing well without paying any costs. This is called a royalty interest. The remainder of the revenue interest is divided up between the project manager and the investor group. When the deal is structured with a royalty interest greater than 25%, it is usually because someone has carved out an overriding royalty interest.
On the cost side, we are looking at the cost of buying the lease as well as drilling and completing the well. The investor pays these costs on either an actual "invoice-cost" or "turnkey" basis. The invoice-cost structure means the investor pays the actual cost to drill and complete the well after paying a one-time overhead fee to cover the expense of managing and offering the project. With the invoice-cost structure, the number one goal for both the company and the investor is to produce a successful well so as to create revenue for both parties. That is to say, the company doesn't profit unless its investors profit, often resulting in a more favorable partnership for investors. The turnkey structure, on the other hand, is a fixed amount set by the project manager, which is typically double or more than double the actual cost to drill and complete the well. The turnkey structure often affords the company a profit whether the well is successful or not. In both instances, it's a good idea to get a feel for how much the drilling and completion of a well may cost. This information can be obtained by doing some research on previously drilled wells in the area based on depth. For example, in the State of Louisiana, the Louisiana Mid-Continent Oil and Gas Association, www.lmoga.com, offers average drilling cost information.
Does the Projected Monthly Production Justify the Money You Are Investing?
In an established oil and gas area, the projected production and payout is based on the production of nearby wells. A simple rule of thumb is that you want to see projections that (at current oil and gas prices) will return your entire investment in 24 months or less. If the projected production doesn't support a 24-month return on investment or better, the investment risk may be too high given the expected return. The exception to this rule, however, is that a three to five year payout may be justifiable if there is very little risk associated with the project, as is the case with some drilling and production projects.
Conclusion
In summary, when investing in oil and gas, it's essential that you partner with people you trust, that the terms of the project are fair, and the project has a strong likelihood for paying back your investment in short order. In addition, keep in mind that you may have to participate in several projects before you hit a commercially productive well. A multi-well program has the potential to mitigate your risk by allowing you to participate in multiple wells from a single investment. To learn more about evaluating oil and gas investment opportunities and the multi-well concept, call 1.866.859.7827 or email your questions to info@lonestarsecurities.com. To find out if you qualify for an oil and gas investment, go to http://lonestarsecurities.com/questionnaireRJDC.html.