Oil & Gas
One of the key areas brokers focus on is energy, particularly oil, therefore it is often recommended that their customers invest in oil and gas private placements. According to data filed with the Securities Exchange Commission (SEC), since 2008, approximately 4,000 oil and gas private placements have sought to raise nearly $122 billion in investor capital. However, oil and gas private placements suffer from the following risks that often outweigh any potential benefits of these investments including securities fraud, conflicts of interests, high transaction / sales costs, and investment risk. Many of these products pitch that advances in drilling technology have turned previously inaccessible reservoirs of fossil fuels into potentially viable prospects. This fact, along with increasing energy prices has led to an influx of companies seeking to profit from demand for oil and natural gas.
The largest risk for investors in oil and gas projects is securities fraud. An SEC Investor Alert listed some common red flag sales pitches often made to investors including: (1) Sales pitches referring to the high price of oil and gas; (2) “Can’t miss” wells or “guaranteed” returns; (3) Promises of high returns with little risk; (4) Sales pressure to purchase quickly; and (5) Sales pitches touting new technology to get higher production out of low-producing wells.
The second major risk for investors is that oil and gas investments suffer from substantial conflicts of interests due to the relationship between the promoter and the investors. Generally, the promoter of these investments is a well drilling contractor and the investor risks their capital hoping that the promoter will wisely use their funds so that investors profit. However, investors, who take on all of the risk, often are not even entitled to the majority of the profits. Many oil and gas companies only hold a leasehold rights – as opposed to actually owning the land itself – and the investor’s share of the profits may be as low as 40%.
In addition, the promoters of the oil project make money regardless of whether an investor receives any return and in fact has an interest antagonistic to underlining investors. The promoter makes management fees and also profits off of the drilling costs. The promoter has an additional right to sub-contract out, at an inflated rate, work to others guaranteeing further profit. Given the structure of these deals, often times the promoter ends up making more than the investor does. Thus, promoters have incentives to make their oil and gas projects sound as attractive as possible regardless the true probability of success.
Third, the high transaction costs makes oil and gas private placements extremely risky. In a typical oil and gas investment, investor capital goes towards three areas: 1) paying for the drilling costs, 2) management fees, and 3) the syndication costs of the broker dealer. The management fees are generally a flat a fee that will go directly to the promoter. The drilling costs are the costs of developing the well covered above. Finally, syndication fees often surpass 10% of the amount invested. As a result, between 30-35 cents of every dollar invested goes towards management fees, syndication fees, and profits to the promoter as general contractor. Any investment where only 65-70% of your money is working for you is lose-lose proposition under anything other than booming market conditions.
Finally, the investment risk for oil and gas investment is that exploration for oil requires a significant capital investment to cover the cost of drilling and well development. Even if a company has the operational capacity to develop a well these ventures are still very risky because geologists cannot guarantee that the well will produce enough marketable fuel to cover the costs of development.
Recently, the price of crude oil has tumbled to five year lows. Under these conditions it is highly unlikely that the use of novel and costly technologies to extract oil from previously inaccessible places will result in profit for the investor when costs are taken into account.
Investors who have suffered losses in these products are encouraged to contact our firm. Brokers who sell oil and gas investments have an obligation to make sure that the investment is suitable for the investor and to disclose all the risks associated with the product. Our consultations are free of charge and the firm is only compensated if you recover.