Many oil and gas investments are legitimate but scams lie in wait for the uwary investor eager to capitalize on the opportunities created by skyrocketing energy costs.
What are Oil and Gas Investments?
There are many varieties and flavors of oil and gas investments. They include limited partnerships, complex lease agreements, and general partnerships. Limited partnerships involve the sale of partnership units to raise money for drilling activities. The sponsoring company charges a fee for managing the project and keeps a percentage of the revenue should there be any.
Investors are offered a large first year tax write-off and quarterly cash distributions from the sale of whatever oil and gas found by the partnership until the wells run dry. General partnerships can differ from limited partnerships in a couple key ways. First, general partners sometimes assist in the operations of the project. Second, they’re personally responsible for debts incurred by the partnership.
Oil and gas drilling partnerships are risky, speculative ventures that are difficult to turn into cash should you need it and they generally have a long holding period.
Oil & Gas Investment Scam Methods
One technique used to defraud investors is to set up the the business entity (LLC or corporation etc.) in one state, have the drilling operation in another state, then sell shares to investors in every state but those two. This makes it less likely an investor will drop by to look things over and discover the company has neither offices or drilling fields. This setup is a tried and true method for many investment schemes because it’s so effective at reducing their chances of being caught.
Oil and gas investment schemes find investors to dupe through both telemarketing boiler rooms and email promotions (SPAM). The staff of these operations know little or nothing about the oil business. They’re high-pressure sales experts with tons of experience squeezing hard earned dollars from unwary consumers. Should you respond to one of their emails or talk to one of them on the phone, you’ll be told about the riches that await you, because this is one investment that just can’t miss. Profitibility isn’t even in question. You’ll make money, a lot of money. Then they’ll offer to send you some brochures to look over if you’re not already convinced. Their printed material are often quite professional looking because they want you to see how rock solid this investment is. That’s enough to fool many novice investors, but a savvy investor would never, ever be willing to sock money into something based on a cold call and glossy brochure.
Oil & Gas Investment Scam Warning Signs
Securities regulators warn investors to be wary of the following claims made in typical high-pressure sales pitches, whether through unsolicited telephone calls, email messages, or on internet message boards:
- “There’s no risk in the investment.”
- “This well is guaranteed to make money.”
- “A geologist gave me this tip.”
- “There has been a huge “discovery” in an adjoining field.”
- “A well known oil company is planning to drill in the area.”
- “This deal is open to only a few, unique investors, such as yourself.”
- “Only a few shares are left so you need to send us money right away to get in on this deal.”
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.
Oil & Gas Investor Checklist – Avoid Getting Scammed!
- 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.
- 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.
- 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.
- 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?
- 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 You Should 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 Go 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 at www.nasaa.org. It is a good idea to contact your securities administrator before you invest.