If you’re like a lot of people you’re probably hungry for investment options that can produce above average returns. Well, one option that is open to the general public, but is not well understood is opportunities in the oil exploration and production industry.
You might be asking, how do I invest in an oil well? There are lots of ways to get into oil and gas. The two primary methods of investing are purchasing stock in an oil and gas company (public), or investing through direct participation programs (private). Buying stock in oil and gas companies is well covered elsewhere, but the nuts and bolts of private investment is less understood. So, for those of you want to learn about oil and gas investing, we’ve brought you a two part interview with Charlie Rushton.
Charlie, known as the “go to oil guy” is an oil and natural gas professional whose focus is on providing individual consulting and education services. He is a former restaurateur and has appeared in numerous webpages. Charlie demonstrates an infectious enthusiasm for introducing investors to the benefits of investing in the oil patch. He has been kind enough to answer a number of questions for us.
1) How can small investors (e.g. those with around $10,000 or so to invest) get into directly owning oil wells? What does the investment process look like?
The main way of directly owning oil wells is through Direct Participation Programs (DPP’s). The entry price varies based on the size of the project. Investors can get involved for as little as $5k with the smaller oil and gas operators who are seeking to expand production up to projects that cost $50k-$100k per 1% Working Interest.
The process is as follows:
It starts with receiving a prospectus or Private Placement Memorandum (PPM), outlining the specifics of the project, costs involved, the contracts, and projected returns. These are created for both new drills and rework projects. It will also stipulate what you are buying such as a 1% Working Interest (WI) and a .75% Net Revenue Interest (NRI). The NRI is determined by the royalty paid to the mineral owner when the lease was created.
It should outline the monthly costs; such as the operator fee, pumper fee, electricity, water transportation if any, admin and filing fees to the State. Further down the line when production has commenced there may be routine maintenance expenses. There is also the state levied tax and other property taxes. These are all known as Lease Operating Expenses (LOE’s).
After you complete your due diligence, assuming you go forward and make the investment, you then wait for the offering to close and drilling to start. It is always a good idea to ask how much funding is left to raise as this is a good indicator as to how effective they are at raising capital which points to their credibility. Once the well is put into production, you will begin to receive the proceeds from the sale of the oil less the NRI and monthly expenses.
Therefore it should look something like this:
Amount invested $10,000
LOE total 15%
If the well comes in producing 50 Barrels of Oil Per Day (BOPD) and the price of oil is $90 on the day of sale, then in the first month the figures would look like this:
50BOPD x 30days x $90/barrel = $135,000.00
Less Royalty 25% (33,750)
Less LOE 15% (15,187)
Therefore the distributable amount to the Working Interest holders is $86,063 of which in this example the investor owns 1%, which equates to approx $860 revenue. If production remains at this level for the coming year then you will make your money back in a little over 11 months.
This example, while hypothetical is not an uncommon return, provided you have invested wisely.
However this investment is not without risk. As a working interest participant you can be liable for any problems that occur such as environmental issues, injuries etc, which the operators insurance policy may not adequately cover. To this end it is always advisable to own the interest through an entity such as an LLC. I woulds also highlight that checking the insurance policies of the operator are a must.
A limited partnership (LP) framework can also be used in these projects which also has its benefits and restrictions. Your liability is limited to the initial investment amount in the event of a mishap, although there may be additional fees for managing the LP and the tax benefits may not be as useful. This however is a good way to get started as your risk exposure is minimized.
The size of the project will govern the amount needed to be raised and therefore the entry level dollar figure, since there are strict SEC regulations as to how many participants are allowed to be involved in any one project.
For example, a new 2 well drilling program may require $5M of funding in which case a 1% WI would cost $50k to participate. In this case if you wanted to get involved then finding an LP that has acquired an interest may be the way to go if you have $10K to invest.
However, an 8 well lease acquisition which requires rework and maintenance might require $400k of capital and a 1% WI might cost $4k to participate. The returns in both of these examples could be in the same ball park.
2) How should small investors think about valuing oil well opportunities? Are there any metrics they should look at? What is important when you evaluate a potential oil well investments?
Because of the speculative nature of investing in oil, how they can be valued will come down to the type of project in question. If it is a new drilling program, then essentially all the projections are pro forma’s, based on the estimated recoverable reserves garnered from previous well logs on the lease and the other producing wells in the area. Anyone in the field will tell you that all the data in the world can point to a reservoir, but until you drill the well and hit oil, you don’t know.
With producing wells it is easier and more tangible to value them, as you have actual figures to go by. While all investors want to make the biggest returns possible, knowing what you are expecting as a reasonable rate of return will help. Using a 60 or 120 moving day average of oil price or 180 days to be very conservative will help the investor to ascertain a fair strike price.
To help evaluate the price, current production data, accurate engineering and reserve reports will make the evaluating task clearer. The industry standard is that if you cannot expect to make at least a 5 to 1 return on the information you have then the deal is probably not worth doing.
Wholesale deals usually price the oil well based on the per day production. With oil prices today, this figure is approx $50K/barrel, if there is no upside or increased potential. So a single well producing 4BOPD may sell for $200k, whereas if there are additional payzones that have yet to be exploited the price per barrel may go to $60k/barrel or more.
I think the most important thing is to know who you are dealing with. What is their reputation, how long have they been doing this, and as an operator are they producing what they say they are producing. All this can be found and checked in public records. Even if this all checks out, get on a plane and go and see the prospect. Better to spend $500 now than lose $10k later.
The due diligence phase cannot be stressed enough, just like buying a piece of real estate for investment. All records are verifiable, including title searches that they are the legal owner and have the right to sell the property. There are lawyers versed in the oil and gas industry that can do this for you.
If you are not familiar with reading contracts get someone who is to read your contracts. There are some crafty paragraphs in some of the operating agreements that can leave you high and dry, or expose you to having to put more money in if the project costs overrun. Investing in turnkey programs is advisable until you have more knowledge, confidence and experience.
Here are some key areas to focus on when evaluating a project:
1) Consider the project: How did the company come to choose this particular site or lease. Is there reliable and plentiful data to support their thinking? Are there other producing wells in the area and do their projections mirror them or far exceed them?
2) Look at the team: Are they using top notch geologists, and what is there track record? Are they in good standing in the community and do they care for the environment? Are they familiar with the area or new to town?
3) In the future: What are the plans for the future? Do they have future projects lined up? The last thing you want is to invest with a fly by night company that takes your money, hits a duster(dry hole) and runs.
4) Ask questions, and lots of them: There are no stupid questions, so ask away! If the company dodges them or doesn’t have concise answers, chances are they don’t know what they are doing. Only by asking your questions can you become comfortable with the investment. Transparency is very important, so if they have something to hide you need to know.
5) Due diligence: Always do it or get a qualified professional to do it on your behalf. Check out the state agencies and see if they have a clean record.
6) Heed the warning signs: There are never any guarantees in these investments, so any company guaranteeing you a return should be a warning sign. If a company hesitates to give you info or tells you it is now or never, choose never. Listen to your instinct. As an investor your instinct is one of your most valuable tools, use it wisely.
While returns in this sector can far exceed many other sectors, if it still sounds too good to be true then may be it just is.
If you want learn more about about Charlie or want more information about oil well investing, he can be reached at: (805) 403-7080 or via email: contact@Hardrockoil.com. His website iswebsite is: http://usoilinvestment.com. If you want to learn more about how to value oil well opportunities, check part 2 of our the interview here.