Crude oil prices are driving up profits to levels never seen before in both large-cap oil companies and small-cap companies.  Another group that is reaping the benefits of high oil prices is the individual investor.

There is nothing more lucrative right now than holding an oil and gas interest, and evidently independent drilling companies are taking advantage of the individual investment capital floating around in the market.  Drilling partnerships are being advertised on the radio and have become prolific across the internet.

“All that is required is an initial investment of $52,000 and you could see returns of $6,000 per month for the next 20 years.”

Sounds too good to be true, and like an educated investor, you ask yourself “where’s the risk?”.  Good question.

The risk lies in your business partner.  Namely, your drilling partners.  Companies like PetroInvest and Northstar Energy offer partnerships in what they call low risk wells.  They’ll go drill new offset wells in fields that are already producing, thereby lowering the chances that they’ll end up with a dry hole.

They may offer you a 1% working interest in the well(s) for anywhere between $10,000 and $80,000 up front.  (Remember what a “working interest” means?)  Depending on the program, this is just to drill the hole.  After they log the hole and convince themselves it’s worthwhile to finish, they’ll come in and complete the well.  At that point in time, they’ll ask you for more money.  In this case, 1% of whatever it costs to complete the well.

Some things you want to look at when considering a drilling partnership are the fee allocations for the partnership.  One partnership I looked at allocated 15% of the initial capital to cover finders fees, initial management fees, organizational fees, etc.  In short, you’ll never see a return on that 15%, resulting in a longer payout period.

On top of that, one prospectus I looked at offered a 1% working interest, but the NRI was only 56%.  This means that you only receive 1% of 56% (or a net of just over 0.5%) of the production, but pay a full 1% for the operational costs and expenses.  Conveniently, several other “industry partners” were taking an overriding NRI right off the top, not to mention the land owners take.  This means that the said “industry partners” are not required to pay expenses, even though they take 44% of the production.

Some tips:

• Always know who you’re partnering with.  It’s a business venture after all.
• Make sure the game is played on a level playing field.  Would you want your business partner to get a hefty chunk of the proceeds yet pay no expenses?
• Get a history synopsis from the driller. How many wells have they drilled in the last 10 years? How many were dry, and how many are still in production?  Which ones are close to the proposed drilling site for the partnership?
• Get a list of ALL the players involved.  Do they contribute to the partnership?
• Have an oil and gas attorney, as well as your financial planner look over the offering.  Is there some fine print you’re missing?

With oil prices at their current levels, you’ll be paying a premium for any drilling operations over costs from just over a year ago.  And you can bet all parties without a working interest will be making a handsome profit on your money as well.

Be picky, and educate yourself before mailing in your check.  Talk to some clients and see what their payout time frame has been.

And only participate with business partners who have a vested interest in succeeding!

Disclaimer: I make absolutely no recommendations for or against any of the companies listed in this post.

Additional Resources
Schlumberger Oil Field Glossary
Oil and Gas Drilling Partnerships - Are they right for you?
Oil Partnerships - How to protect your investment
Investing in oil and gas (white paper)
A USPS fraud warning about oil and gas investment offerings

Leave comments below. Subscribe to Comments