Oil and Gas Investing

Accredited and Sophisticated Investors

Recently I was asked to explain the difference between accredited and sophisticated investors.  A little background should help: 

The SEC definition of an accredited investor includes an individual or married couple with a net worth of at least $1 million OR annual income exceeding $300,000 ($200,000 if unmarried) in the two most recent years.  The definition also includes certain businesses, trusts, and charitable organizations.  The full definition details are explained on the SEC’s website.

The SEC also allows participation in oil and gas investments by “Sophisticated Investors”.  These are individuals who do not necessarily meet the accredited investor standards but have a sufficient knowledge and experience in financial and business matters to evaluate the risks and merits of an investment.  This definition includes individuals with prior experience investing in prior placement oil and gas drilling projects or investors who represent that the contemplated investment will not exceed 20 percent of their net worth at the time of purchase.  Additional details are available on the Absolute IPO website.

These standards are intended to help protect potential investors from experiencing unsustainable loss of income or net worth when making a decision to invest in private placement oil and gas partnerships.  And this just makes good sense.  There’s risk associated with any investment and the prudent investor will have the knowledge and money to sustain the risk regardless of the project’s degree of success or failure.

Your comments or questions are welcomed.

Oil & Gas Well Drilling Success Rate

Another question I frequently receive from people thinking about making an investment in a US oil & gas drilling project concerns success rate.  Most want to know the probability that we will hit oil and/or gas.  James Williams, publisher of the Energy Economics Weekly, says “It depends on whether it is a development well or exploratory.  About 91 percent for development, 45 percent for exploratory and 88 percent overall.”  As the chart indicates, this confirms our own research for oil and gas wells drilled in Texas over the past 12 months.  Our analysis shows that for this period, on average, 90.84 percent of drilled wells were put into production.  That is they began producing and selling oil or gas or both. 

But this isn’t the whole story.  Well drillers/operators have a pretty good idea of how much oil and/or gas a well will produce once the well is drilled and tested.  At that point an assessment is made as to whether to complete the well.  If the probable production payout of the newly drilled and tested well indicates that the additional cost of completing the well will be recovered plus some additional return, then the well is completed and put into production. That way the investors will get at least part of their initial investment returned to them.   

The more important question for investors is: “What are the odds that their investment will be paid back AND return a profit”.  To my knowledge, data to answer this question is not available.  Some wells that return a profit can payback the initial investment many times over, thus making up for the ones that don’t fully pay back the initial investment.  I think that about one in 5-6 producing wells will ultimately reach “return on investment” status.  When you factor in tax savings, these odds improve somewhat.  This is why it’s not a good idea to think of an investment in a private oil and gas drilling project as a one time thing.  Knowledgeable investors will invest in a number of individual projects to improve the odds of seeing a return on the sum total of all their investments.  To some degree this also explains why investors join together to invest in oil and gas drilling projects...that way they can participate in more projects and further increase their odds of achieving real investment success.

I welcome your comments on this post as well as any verifiable statistics on the subject you care to offer.  Just email me or post your comment.

Joe Ireland

Direction of Oil and Gas Prices

The number one question I get from investors considering investing in an oil and gas drilling project is “Do you think oil and gas prices will remain high?”

My quick answer to this question is: Yes – At least for the next 6 to 18 months.  That is to say, I think oil and gas prices will remain at 2004 averages or better over this period.  Why? Well oil and gas prices are supply and demand sensitive.  The supply is constrained by the aggregate world oil producers’ ability to quickly pump, transport and refine more oil and LPG while the demand side is based on steadily increasing trends in worldwide petroleum energy consumption.  While demand for oil and gas may eventually be slowed by long-term shifts to alternative energy sources, the investments and incentives to make that shift will be huge and will take time for new technologies to take hold.  

Beyond the 6 to 18 month period the overall health of the world economy will play the biggest role in determining prices.  Higher energy costs will put a drag on economic growth.  Whether such a drag would be enough to slow, stop, or reverse the demand for petroleum products is anyone’s guess.  But since we are dealing with a limited resource, we all know that the price of petroleum products will trend up over the long-term.

These are just my opinions.  You will want to draw your own.  One excellent source of trend data and forecasts is the US Department of Energy’s Short-Term Energy Outlook.

If you want to get even more input on future :  Check out Jim Frazer’s “The Energy Blog”.

I invite your comments on this post as well as any questions you may have about directly investing in oil and gas projects.  Just email me at: questions@lonestarsecurities.com and I’ll do my best to respond. 

Joe Ireland

Managing Member

Lone Star Securities, Inc.