Oil and Gas Invest

Direct investments in oil&gas can provide potential returns, cash flow and tax benefits which exceed traditional investments. However before making direct investments in oil&gas wells, investors need to assess and control the risks involved, to the extent possible. The person you are investing with should carefully explain and fully disclose the potential risk factors. Also you should ask about the liquidity of the investment. However a few items to consider, among other things, are the following:

• Are the wells developmental wells or exploration wells?
• What is the past performance of the wells in the area?
• What do the geological and/or engineering reports say?
• How diversified is the investment?
• What are the bios of the producer/operators?
• How are you going to hold the investment
  in the case of working interests?
• NASAA's warning against oil and gas investment fraud.

Note: This is not intended to be a complete list of due diligence procedures as each investment is different. There are many details regarding a potential investment which should be addressed, which may include but are not limited to: transportation, sharing arrangements, deal terms, potential liabilities, further development, etc. Investors are responsible for their own due diligence procedures. These procedures do not represent all the procedures and checks you should consider before investing and are intended only as certain suggested considerations you might consider before making an oil and gas investment.

Are the wells developmental wells or exploration wells?

Exploration wells are typically used to describe wells in areas where there are no proven economic oil or gas wells. Certain of these types of wells may be called 'wildcat' wells. Exploration wells involve a high amount of risk as well as potentially high returns. The risk that investors may not find oil and/or gas is 'geological' risk. Most of the wells drilled today are development wells.

Development wells are wells drilled in areas of known reserves. As a result, the risks involved are considerably lower. Typically with developmental wells the risk is not geological (e.g. whether natural gas or oil will be found), but mechanical risks. Mechanical risks are things that may go wrong in the drilling process, like a section of pipe is dropped down the hole which then has to be 'fished' out. However over the past decade or so, with advances in technology, the mechanical risks have dropped considerably. As a result, with most wells drilled being developmental wells and advances in technology, the successful completion rate of wells today has been reported to be significantly higher compared to the successful completion rates from the 80s and early 90s. Note: successful completion doesn’t necessarily mean economically viable.

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What is the past performance of the wells in the area?

The performance of other wells in the area is another good indicator of the potential returns. If the other wells in the area are doing well either with your operator or others, then this should provide some level of comfort with the wells being proposed. Most producers will be familiar with how well others wells in the area are performing. As a side note, investors should not forget to take into account the tax benefits which will be derived from the investment. Of course the particular tax aspects vary according to an investors particular tax circumstance and investors should consult with their tax advisors on what these benefits may be.

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What does the geological and engineering reports say?

Typically the sponsor will have geological or engineering work done on the prospects. Investors will want to ask for a copy of these reports and gain an understanding of the potential of the reserves of the prospect.

These reports may be difficult to understand for someone who doesn’t have the proper understanding of geology and engineering. As a result, an investor may want to have an advisor who can help interpret the findings.

However approaching the geological and engineering information with a little common sense and research and in context of some of the other cursory inquiries mentioned within, the investor may have enough comfort level with the prospect.

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How diversified is the package of wells to be drilled?

With every well there are risks involved, including geological and mechanical. A mechanical problem or some other unforeseen event could delay the well or cost additional funds to drill, which may negatively impact your investment return. As a result, just the like the stock market, you will want to make sure that your investment is reasonably diversified to a level you are comfortable with. The amount of diversification will depend on the risk profile of the wells being proposed (e.g. developmental or exploration) as well as the investors investment objectives and risk tolerance.

Diversification levels may be achieved either by the package of prospects being offered by a sponsor (e.g. the investment is in multiple wells), or by allocation of your targeted funds into several projects.

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What are the bios of the producer/operator?

Investors should request the bios of the producer/operator. Bios will provide investors with important background information, including how long they’ve been in the business, which areas they have worked, their success rate, etc.

As a side note, often there are producers or operators who may subcontract out a significant amount of the drilling and geological work. It may also be wise to ask questions about the subcontractors being used and the amount of experience they have in the area.

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How are you going to hold the investment in the case of working interests?

Unlike mineral right owners, working interest owners are responsible for the drilling of the well. As a result, if a liability is generated from this activity, then it is entirely possible that working interest owners could be held responsible. For example, one such liability could be environmental problems. If there happens to be an oil spill or contamination, then the cost of the clean up could be the responsibility of the working interest owners – In other words, they could come back to the working interests for the cleanup costs. However to protect investors from losing more than their original investment, they should consider holding the investment in separate legal entity.

Limited Liability Corporations ('LLCs') are one such entity which may protect the investor from additional liabilities over and above their original investment. However when setting up a LLC or another legal entity to hold a working interest, investors should pay close attention to: (a) the setting up and running of the entity and (b) the tax consequences of the legal structure.

Investors should make sure that in setting up a legal entity, that they seek professional legal counsel to make sure that it is set up correctly and that it is operated in way in which provides them the limited liability protection under the law. For example, if an investor commingles funds from the entity with their personal funds, this may eliminate the limited liability aspect of the entity. Setting up a LLC is usually not expensive and can be done within a few days.

Another consideration when setting up a legal entity is the tax impact of the legal entity. Investors will want to ensure that they obtain all the tax benefits available and that these are not jeopardized by the legal structure. Investors are advised to consult with a professional tax accountant who is well versed in this process and knows their particular tax situation.

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The NASAA has warned against oil and gas investment fraud and schemes

Don't be had !  The NASAA has warned against oil and gas investment fraud and schemes. Make sure you thoroughly check out the any group you might invest with.  The NASAA provides a list of things to check, questions to ask and items to look for along with good background information. This information is below.

OIL AND GAS INVESTMENT FRAUD State securities regulators around the country warn that oil and gas investment scams are alive and well. High oil prices have created a heightened interest in investments in energy-related business ventures.

Most oil and gas investment opportunities, while involving varying degrees of risks to the investor, are legitimate in their marketing and responsible in their operations. However, as in many other investment opportunities, it is not unusual for unscrupulous promoters to attempt to take advantage of investors by engaging in fraudulent practices.

Although some of the con artists moved on to more lucrative venues since the oil boom ended in the mid-1980s, many continued to linger on in the oil field. Now with the constant fluctuation of oil prices, some of these people have made their way back to these kinds of scams. When there is a highly publicized economic circumstance, which creates an opportunity for money to be made legitimately, scamsters follow in the shadows to take advantage of the situation.

WHAT ARE OIL AND GAS INVESTMENTS?

Oil and gas investments take many forms, including limited partnership interests, ownership of fractional undivided interests in leases, and general partnerships. Tax consequences and investor liability vary according to the type of program. True general partnerships in which investors actively participate in the operations of the venture are not securities. A general partner, however, is personally liable for partnership debts.

In a drilling limited partnership, an oil or gas company sells partnership units to investors and uses the money it raises to lease property and drill wells. In return for managing the project, the sponsor company usually takes an upfront fee that averages about 15-16% of one’s investment (commonly referred to as tangible and intangible drilling costs) and also shares in a percentage of any revenue generated. In return, the promoter offers the investor the prospect of a substantial first year tax write-off and quarterly cash distributions from the sale of any oil and gas the partnership finds until the wells run dry.

Drilling partnerships have always been a gamble, but recently, they have proven somewhat riskier than usual. This type of investment is very speculative, is a highly illiquid investment and can have a long holding period.

FRAUDULENT SALES TECHNIQUES

Fraudulent oil and gas deals are frequently structured with the limited partnership (or other legal entity) in one state, the operation and physical presence of the field in a second state, and the offerings made to prospective investors in states other than the initial two states. Thus there is less chance of an investor dropping by a well site or a nonexistent company headquarters. Such a structure also makes it difficult for law enforcement officials and victims to identify and expose the fraud.

BOILER ROOMS & INTERNET PITCHES

In order to attract the interest of potential investors, unprincipled promoters frequently use the Internet and “boiler room” offices with banks of phones manned by salespeople with little or no background in energy exploration, but plenty of experience in high-pressure sales. Their techniques include repeated unsolicited phone calls to members of the public, hyping the profitability of the deal. Some swindlers use professionally designed brochures. Beware of unsolicited oil and gas promotions on the internet and through e-mail. State securities regulators caution potential investors to beware of the following claims in a typical high-pressure sales pitch, whether through unsolicited telephone calls or e-mail messages:

- You will have an interest in a well that cannot miss;

- The risks are minimal;

- The salesperson has personally invested in the venture;

- The promoter has “hit” on every well drilled so far;

- There has been a tremendous “discovery” in an adjacent field;

- A large, reputable oil company is operating or planning to operate in the area;

- Only a few interests remain to be sold and you should immediately send in your money in order to assure the purchase of an interest;

- This is a special private deal open only to a lucky chosen few investors.

INVESTOR CHECKLIST: HOW TO AVOID BEING SWINDLED

State securities regulators advise potential investors not to be afraid to ask the hard questions when solicited for oil and gas investment opportunities. Investors wanting to make oil and gas investments should consider oil exploration and producing companies which are well-established and listed on the New York Stock Exchange.

You can minimize the risk of being swindled if you resist pressures to make hurried, uninformed investment decisions. There are several steps you should take before parting with your money. State securities regulators have developed a checklist of five key areas to examine before investing.

1. The Registration Requirements. Ask if the offering is filed with the office of the state securities commission in your state or the state in which the promoters are located. If so, contact that agency for any information it may be able to provide. If the promoter claims that the offering is exempt from registration requirements in the particular state in which the offers and sales are made, find out which of the exemptions is claimed and the terms of the exemption.

Contact the state securities agency to confirm that the offering is indeed exempt. If the promoter claims a security is not involved at all, find out why and contact the state securities agency and confirm whether it really is a security being offered.

2. The Salesperson. If it is a legitimate deal, the salesperson will not be reluctant to answer questions or provide written explanations to questions. Ask the name of the person offering you the security, where he is calling from and his background, particularly in other oil or gas ventures. Ask what commission and/or other compensation the salesperson will receive.

Contact your state securities agency to find out if the promoter or salesperson has been sanctioned for previous violations of securities laws.

3. The Company. Ask the names of the principals of the company or the general partners offering the security, their backgrounds and experience in the oil and gas industry, and how long they have been associated with the company. Find out the history of the company, its capitalization, assets and retained earnings. What contingent liabilities does it have from other ventures? Does it have sufficient funds to cover unexpected costs? Is the tax treatment of the investments, as claimed by the promoters, supported by the Internal Revenue Service?

Find out the company’s or general partners’ history in drilling operations. In particular, ask how long it has been in the oil and gas business, the number of wells drilled, the number of wells completed as producing wells, and whether the company retained its interests in the wells it drilled. Determine if conflicts of interest involving the promoter are disclosed. All the above information should be contained in a prospectus or “offering documents” that the promoter must furnish potential investors before they commit their funds.

4. The Investment. Make sure funds raised are kept in a separate escrow account until used and that they won’t be commingled with other funds. Also, be certain the funds will not be used for purposes other than those specified. Ask how much money is to be raised and the cost per fractional interest. Ask how much of the money will pay for advertising, salaries, sales commissions and any estimated profit to the company. Ask what type of conveyance document will be provided after any investment is made.

Assuming the well is completed, ask what the completion costs will be for each investor, including additional commissions to be paid (the purpose and amount), and whether investors may be obligated to pay in more money in the future. Ask what tax incentive might be available if a dry-hole is encountered and for intangible drilling costs. Finally, evaluate the risk involved in making the investment. Is the well to be drilled a wildcat (drilled in territory not known to be productive) or is the drilling to be done in an area of proven oil reserves?

5. The Lease. Secure a legal description of the property on which the program is to be drilled. How and when was it acquired? Is the principal selling the lease to the venture at the acquisition cost, and if not, how much profit is being made? Ask for a description of surrounding property, including local well completions and a geologist’s report on the area. You will want to know if the lease is already in default and whether there is any overriding royalty or landowner’s royalty or other leasehold burden being paid.

Ask for a disclosure of the person(s) selling the lease, the cost of the lease and any relationship between the lessor and the operator. Secure a statement of the depth of the well to be drilled and an indication of when drilling is to begin. Insist on seeing a copy of the operator’s contract with the promoter.

ADDITIONAL QUESTIONS TO ASK BEFORE INVESTING

The checklist of questions to ask and information to obtain is long and it will take time and perhaps even money invested in outside consultation before you feel comfortable risking your money in the investment. It is always advisable to seek the advice of a neutral expert before committing your funds to any investment deal. Be sure to consider the following questions:

Who will be responsible for payment of taxes? Will they be paid out of the investor’s share?

What is the location of available pipelines, or what method will be used to transport and sell any production?

What is the name and address of the operator? What is her/his experience with ventures of this nature? What are the terms of the agreement with the operator, including the compensation terms?

How will the decision be made for completing the well or abandoning it? Who will make that decision? What is to become of funds received from the salvage value of equipment on the lease?

WHERE TO TURN FOR HELP

The securities administrator in your state, province or territory is responsible for the protection of investors. If you have questions about an investment, contact your securities administrator. You can locate your securities administrator on NASAA’s website by clicking here. It is a good idea to contact your securities administrator before you invest.

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