Do you want to invest in oil exploration companies? If YES, here is a complete guide on how to invest in oil and gas wells profitably with no money or experience. It is not a secret that investing in oil and gas wells are one of the ways investors make lifetime fortunes, but for you to make this kind of investment, you must be indeed ready for it. This is because investing in oil and gas wells is not for everybody; you must know what it takes, and you must have it.
Let’s be clear here, investing directly in oil and gas wells is different from buying the shares of oil companies or units of master limited partnerships (MLPs). Direct investment in oil wells is indeed a more focused and concentrated way of investing in oil and gas.
When carrying out oil well investment, it is usually done under a program called Direct Participation Program (DPP). One can participate in the Direct Participation Program in different ways, and they are as follows;
- Working Interest Ownership – This DPP program is the traditional investment channel that is used at the start of oil drilling programs in the early 1920s. Here, you get to own a piece of the well with others, and your responsibility is higher than those in a limited partnership (LP).
- Limited Partnership Ownership – Limited partnerships for oil and gas wells started in the mid-1970s. The most obvious difference between the two is that LPs wrap working interests inside them to give the general partner more control, while adding management fees and backend revenue sharing after the payouts.
Table of Content
- 7 Things to Consider Before Investing in an Oil and Gas Well
- How to Avoid Being Scammed When Investing in Oil and Gas Wells
Cost Implications of Investing in Oil and Gas Wells
The entry price for any Direct Participation Program (DPP) varies based on the size of the project and the degree of management you want to be in charge of. Investors can get involved for as little as $5k with the smaller oil and gas operators who are seeking to expand production. But on the other hand, there are projects that cost between $50k-$100k for a 1% working interest. Yes, it can get that expensive.
How to Invest in Oil and Gas Wells Profitable With Little Money
If you want to invest in oil and gas wells directly through a DPP program, you would have to seek for a prospectus or private placement memorandum (PPM) of the company you want to invest with. The private placement memorandum of the company shows you what you need to know about the project such as the costs involved, the contracts to be made, and projected returns.
It will also stipulate what you are buying; for example, a 1% working interest (WI) and a 0.75% net revenue interest (NRI). This memorandum is created for both new drilling sites and rework programs. The net revenue to be received by the investor is usually determined by the royalty paid to the mineral owner when the lease was created.
Asides from that, the DPP also outlines other monthly costs, such as the operator fee, pumper fee, electricity costs, water transportation charges (if any), administration costs and filing fees to the state. There may also be routine maintenance expenses to consider when the project starts running. While you are going through all these, you should equally run your research on the company so as not to make any wrong investment. Never go by what they say alone.
When you have gone through the private placement memorandum properly, you can then make your investment and then wait for drilling to start.
Before you make an investment though, be curious to know how much is left to be raised so you know how long you have to wait before receiving returns on your investment. 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 wellhead expenses.
Most investors think that investing in oil and gas wells is a get rich quick scheme, but this is not true. For a lot of reasons, your money can get tied up for several months at a time before work actually takes off. When work finally commences, it can be another three months before any payout can be made. And sometimes, it can take much longer.
You also need to be prepared because things sometimes don’t work out like they say it will. You may invest in an oil and gas well that is unproductive. This is where the risk comes because if this happens, you will lose your investment.
This is why you need to find a company that has a track record of success, and you must do your due diligence on the area and the specific oil and gas field where the company is working. If possible, ask to be shown around the field by the geologist.
Restrictions to Investing in Oil and Gas Wells
Investing in oil and gas wells is not child’s play, and as such you have to meet certain requirements. They include;
- You must be an accredited investor: Being an accredited investor means that you must have an individual net worth (or joint net worth with your spouse) that exceeds $1 million at the time of the purchase, or have income exceeding $200,000 in each of the two most recent years (or joint income with a spouse exceeding $300,000 for such a period).
- You must have insurance: You must have some form of insurance to cover your investment. Which insurance option you go with will depend on the investment opportunities you have and may also depend on tax considerations. Limited liability corporations get a K-1 tax form. Owners of direct working interests receive a 1099 tax form by January 31 of the following year showing income received.
7 Things to Consider Before Investing in an Oil and Gas Well
- Consider the kind of project involved
There are two ways one can invest in oil wells; the wildcatting project and developmental drilling. The wildcatting project is where a team is exploring in a “green” field. It is usually a new field, and the chances of losing a great amount of money in this kind of project is high.
The developmental project on the other hand is where a team is drilling next to or very near existing and productive oil wells or oil fields. This kind of project is usually successful, and sometimes the success rate can be as high as 100 percent. As an investor, you should always look out for these kinds of projects.
- Consider the people involved in the project
You need to make sure that the best hands in the field are the ones handling the project. Oil and gas drilling is quite complex and complicated so you should know who to hand over your money to. Again, the people managing the deal must be honest, have integrity, show professional ability and have experience.
- Find out their success rate in drilling
If you’re thinking of investing in a new drilling project, compare the operator’s number of wells drilled to the number of wells producing. Also compare the company’s performance to the country and state averages. Anything less than an acceptable average should be a no no for you.
- Look at the operator’s track record in the industry
Don’t focus solely on the project you’re interested in investing in; you should look at the success rates of several of the operator’s previous projects.
- Consider the size of their reserve
The size (and producing characteristics) of the reservoir of the company you want to invest with has a lot to do with whether or not a project will make economic sense. The size of the reserve can be open to interpretation, but similar projects with similar geology nearby will give you some estimate. Importantly, find out the average lifespan of similar oil wells in the area to get an estimate of what your own would be.
- Consider if you can get a better deal elsewhere
After explanations sometimes, you can come off thinking you have gotten an awesome deal, but this is where you need to take a step back and take a good hard look at the specifics of the project. How much of your entry capital is going to direct costs? Can you get a better deal elsewhere? If you think you can’t, then go with the present company, but if you can, switch sides; but you have to consider other variables before doing that.
- Consider what you hope to gain from the deal
We all make investments with certain expectations. When investing in oil and gas wells, you need to consider what you aim to get out of it. If you are in it for monthly income, you have to note if similar projects in that area provide the returns you’re looking. If you’re looking for a tax break, will the project fit your needs?
Advantages of Investing in Oil and Gas Wells
Oil and gas investments offer a wide range of benefits, making them an attractive part of any high net worth investor’s portfolio. Here are some of the reasons why you should start making investments in oil and gas wells.
- It is a source of passive income
Passive income is described as an income you earn without breaking sweat, and this is one of the things investing in oil and gas wells can do for you. Quality oil and gas investments can provide stable, passive income for decades, often with high rates of return.
There has been a whole lot of improvements in the sector which has significantly reduced the many risks hitherto inherent in the business. If your investments are made in targeted well researched areas, it can lead to having outstanding returns on investment.
Investments in the smaller companies and limited partnerships can occasionally pay off big. A single well can generate many times its costs if drillers strike oil, and the well can pay dividends for many years.
- You get a lot of tax incentives
Oil and gas investments come with a lot of tax incentives. Investors in oil and gas wells can gain tax advantages, especially if they invest in limited partnerships. Intangible Drilling Cost deductions provide up to 60-80 percent of well expenses off taxes in the first year.
And 15 percent of the property’s gross is tax free. You’d be hard pressed to find a better incentivized investment opportunity. Investors can also benefit from what is called Intangible Drilling Costs, where a percentage of their income in the first year is written off to cover for incidental expenses.
These expenses generally constitute 65-80% of the total cost of drilling a well and are 100% deductible in the year incurred. For example, if it costs $300,000 to drill a well, and if it was determined that 75% of that cost would be considered intangible, the investor would receive a current deduction of $225,000. Furthermore, it doesn’t matter whether the well actually produces or even strikes oil.
- Can be easily diversified
Oil and gas investments have historically provided a useful diversifier against the overall economy. When gas prices rise, economies tend to slow. This could cause the rest of your stocks and funds to stumble. But when oil and gas prices rise, oil and gas stocks tend to rise with them. An exposure to oil and gas stocks can help insulate your portfolio against economic slowdowns caused by oil shocks.
Risks of Investing in Oil and Gas Wells
As there are advantages to investing in oil and gas, there are also disadvantages. These disadvantages are not given to scare of a potential investor, but to allow him or her see what he or she is getting into. Some of the downsides of this investment include;
a. It is highly volatile
Oil and gas investments can be subject to wild price swings – especially when investing in smaller companies. If you get involved in exploratory drilling projects, you can easily lose a great amount of money. Diversification is the key to oil and gas investing. Losses of 50% or more are not unusual, and you can lose everything on any project.
While you can usually quickly sell shares in larger companies, you may have a hard time finding a buyer for shares of smaller companies. In some cases, you may have to redeem your interest with the company or limited partner directly. This is frequently the case with closely held, non-publicly traded companies and limited partnerships. Don’t become involved in these unless you are willing to tie up your money for a while.
c. Risk of oil spill
Another risk in the sector is that a company could have an accident, such as an oil spill. This type of accident can cause a company’s share price to go into free fall.
BP saw its stock fall in the wake of the Deepwater Horizon oil spill in 2010. The stock was trading around $60 prior to the spill and dropped to as low as $26.75, a decline of over 55%. The Deepwater Horizon oil rig exploded and sank, leaving a sea-floor oil gusher that released over 4.9 million gallons of oil into the Gulf of Mexico. The oil spill had a severe negative impact on marine life and habitats in the Gulf. BP is still dealing with lawsuits and other issues from the incident years later.
d. It is quite complex
Certain kinds of investment are not for everyone because of what is involved in them. This is the same with investing in oil and gas wells. There are special tax rules that govern oil, gas, and mineral investments, and there are rules specific to limited partnerships that may affect you – especially as you file taxes or account for shares when you sell them.
How to Avoid Being Scammed When Investing in Oil and Gas Wells
Because of the potentials for massive profit that can be gained in an oil and gas investment, there are also a lot of scammers involved in the business. Sadly, a lot of fool-proof deals you come across in the industry are put together by smooth-talking telemarketers who use high pressure sales tactics to convince you to hand over your hard-earned money.
If you are interested in investing in oil and gas, you have to know how to look out for red-flags so you don’t lose your hard earned finances to fraudsters.
- Beware of sales pitches that focus on widely publicized oil news
Fraudsters know that people would believe anything they see on the news, and as such they use a highly publicized news item, like volatile gas prices, to lure potential investors and make their deals sound more legitimate.
- Doubt any deal touted as being completely safe
Every investment carries some degree of risk so you should be skeptical of any oil and gas investment opportunity pitched as completely safe. Fraudsters often spend a lot of time trying to convince you that extremely high returns are guaranteed on a particular deal because of certain reasons. This should raise a red flag for you.
- If you keep getting unsolicited materials
Scam artists usually start their scams by sending you investment materials you did not ask for. You have to be especially mindful when working with them. In fact, the best thing to do is simply ignoring investment-related faxes, emails, voice mail messages, and regular mail.
Don’t even let a package full of colorful marketing materials impress you, even if it’s sent by certified or overnight mail. If you want to get interested, you must thoroughly research the company, but if you do not have the time to do this, it is best you toss out the idea. If someone calls to follow up regarding the materials, simply tell him or her you are not interested and hang up.
- If they use questionable sales techniques
An easy way to defraud investors is to set up an LLC or corporation in one state, set up drilling operations in a second state and recruit investors from states other than these two. This makes it difficult for investors to examine either offices or drilling fields. Using a structure that spans a number of states also makes it difficult for law enforcement to uncover the fraud.
- If they claim to have very limited opportunities
Scam artists often try to give you the impression that the opportunity they are promoting is scarce, hoping you will hand over your money hastily before doing any due diligence. Resist the pressure to invest quickly, and take the time you need to investigate before sending money. Be wary of any high-pressure tactics that require hair-trigger decision making. It’s your money, and you should never agree to something you don’t fully understand.
- If you are promised an unusually high rate of return
It should set off warning bells in your head if the investment opportunity you are being sold has an unusually high rate of return. You need to do some research and find out the normal rates by yourself. Any investment opportunity that claims you’ll get substantially more than usual could be highly risky; and that means you might lose money, so be skeptical of the promise of high returns with little risk.
Most scams seem like great opportunities that promise a short window to strike it rich. But you should consider whether the opportunity seems too good to be true. Like they say, if it sounds too good to be true, then it probably is.
- If you are told to keep it secret
Fraudsters are always scared that you would talk to somebody who would discourage you from doing what they say; this is why they usually demand that you keep the deal secret. Any promoter that discourages you from talking about the opportunity with someone you trust, like a loved one, attorney or financial professional is up to no good. If that happens, stop listening, and leave or hang up. Being told not to research an opportunity is probably the best indication that it’s a dangerous risk.
A for real oil drilling and exploration company will invite you to the drilling site and explain the risks to you first hand. They will allow you to hear what the geologist has to say in regard to whether the well is going to be commercial or not in his opinion.
Legitimate oil operators don’t shy away from the investor who wants to learn more about the process of drilling and producing oil wells. They welcome the questions and comments and it allows you to get directly to the people who are making the oil well investment decisions and thereby increasing your knowledge of the oil industry and reducing your risk.
- If you get outrageous fees
Many of these investment scams require exorbitant fees. These investments may also require a large percentage of your investment, if and when there’s any profit. You should make sure that aggregate fees aren’t higher than your expected profits.
- Unhandy reports
If you are being told about a report that is not available for you to read, and being asked to sign documents acknowledging that securities laws don’t apply to the investment, it is another sign that you are being played.
How to Find Direct Oil Well Investments
One way to find genuine companies that invest in oil and gas wells is to ask your friends who have made similar successful investments in the past. If they had a good experience with a particular company, that raises your odds of having the same.
If you don’t have friends that make oil well investments, you can visit online communities that are focused on the business such as MergerNetwork.com. Another is Crestwood Energy LLC which is an independent oil and gas company that allows direct participation in the wells it drills. There are others similar to them out there, you just need to do a bit of research to find them, but always be wary when investing.