With oil and gas prices reaching all time highs, something like a feeding frenzy is taking place across the entire oil and gas exploration and production industry. Nowhere is this more apparent than in drilling project partnerships being offered to individual investors. The number of people looking to make direct investments in drilling projects is increasing with every upward tic of the price of oil. As a result, drilling companies are raising their costs to independents and many royalty owners are raising their required stakes in new projects. At the same time new partnership offerings are coming out every week. Many are put together by new and inexperienced project managers. Oil and gas drilling projects have always come with risk. But in this hyper-environment, more and more high-risk deals are appearing. Potential investors are cautioned to look at these deals carefully.
Investors need a reasonable opportunity for reward versus their investment. My advice is to look at the potential payout of a proposed project versus your investment. You’ll need to do a little math to compare the risk/rewards associated with various project offerings:
Say you are being offered a 1.25% net revenue interest in a project for $90,000. For your investment to break even, the well will need to produce a total of $7,200,000 in revenue ($90,000/.0125 = $7,200,000). If oil averages $60 a barrel, and I don’t believe it will stay that high, your investment well will have to produce at least 120,000 barrels over its productive life ($7,200,000/$60 = 120,000 barrels). You can do the same math for gas or combination oil and gas projects using an anticipated price for thousand cubic feet of gas.
Now here’s the acid test: Look at the surrounding wells and see if any have yielded the amount of gas and/or oil your well will need to produce to return your investment. In this example we used some very optimistic valuations for oil and gas. It probably makes more sense to use pricing numbers like $30 per barrel oil and/or $3 gas. You may want to be even more conservative with your expected price for oil and gas. When the speculative bubble pops, and it surely will, you want to be in deals that still make sense. Of course, if the project does pass the acid test, you still need to examine the geology to evaluate the risk of whether the proposed well is likely to produce at all. And you’ll want be very comfortable that the managing partner has the reputation and industry experience to be a good partner.
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