With over 316 million residents, the United States consumes more energy than any other nation according to the U.S. Energy Information Agency. Across the Pacific Ocean, China and India represent close to 40% of the world’s population with 1.36 billion and 1.25 billion residents respectively, but yet, the U.S. burns more fossil fuels through our use of oil and gas by-products.
As those two countries and other developing nations around the globe continue to grow their economies, demand for goods and services will increase, and consequentially, oil and gas.
Most experts agree that prices will continue to trend higher over the long term, despite the recent drop in oil prices.
Buy Low, Sell High
Oil and gas partnerships investing in projects today may benefit from being cash buyers negotiating with leveraged, anxious sellers looking to clean up their balance sheets. Well-capitalized partnerships in late 2008 and 2009 acted opportunistically sourcing and acquiring deals while the decline in oil and gas prices slowed capital investments by firms carrying high levels of debt.
The Opportunity – Advisor-Sold Direct Energy Programs
Direct energy programs such as oil and gas partnerships offer investors the opportunity to own oil and natural gas directly, potentially benefiting from long-term price appreciation. Investors can earn income from the on-going sale of the underlying asset and as the price increases over time, so could the partnership’s distributions to investors. Additionally, investments in oil and gas partnerships offer tax benefits.
Be sure to read Tax Advantages of Oil and Gas Drilling Partnerships
Michael Mauceli, Founder and Chief Executive Officer of Reef Oil and Gas Companies, has worked with many advisors and their clients since founding his firm in 1987.
He says “most investors would like to invest because one, you get some pretty significant tax advantages as far as investing in oil and gas and two, a potential for good cash flow coming off it and a potential for a multiple rate of return.”
Investing in an oil and gas partnership provides direct ownership of oil and gas which helps to diversify an investor’s portfolio through an allocation that’s not impacted by the whims of the stock market.
Kevin Hogan, President of the Investment Program Association (IPA), an industry trade group that advocates for the direct investment industry and supports investors with educational resources explains, “The essence of the [direct] investment is a non-correlated investment, non-correlated to the general markets, and it helps investors diversify their portfolio.” He continued, “Energy is one of them, particularly one of the [investment products] we support at the IPA.”
Direct energy programs carry many risks that should be carefully evaluated and understood before investing.
In exploratory programs, there’s the risk that drilling a well could result in not finding oil or gas, otherwise known as drilling a dry hole.
High operational costs can also impact the profitably of the partnership and returns to investors. Additionally, if energy prices were to drop significantly, this could reduce or eliminate any chance of generating a profit.
Lastly, oil and gas partnerships do not trade on an exchange; therefore, are generally illiquid. Investors must be able to commit financially and emotionally to the program for the long haul, sometimes ten or more years.
How Sponsors Reduce Risk
Part of any due diligence review should include determining how a sponsor mitigates risk.
Sponsors of drilling programs should employ an experienced technical team with verifiable credentials and relevant experience to the drilling areas the partnership will focus on.
Most sponsors do not operate the drilling and production of the wells, but rather partner with firms that manage these processes. It’s important to understand the sponsor’s course for selecting operators in which they partner.
Reef Oil and Gas Companies partners with dozens of operators and selects those that keep operational costs low. Mauceli says Reef tracks the operational costs of each operator and equally as important, how each sells its oil and gas and for what price.
In the event of a price drop, sponsors may employ hedging strategies to protect against downside risk.
Lastly, many sponsors may focus on proven areas with existing infrastructure. The results of other firms drilling and production activities provide valuable data for sponsors’ technical teams and existing infrastructure supplies the means to get your product to market quickly.
Putting capital to work drilling for oil and gas here in the United States has other, indirect benefits.
Direct energy programs contribute to job growth and stimulating the regional economies in which they invest. Successful discovery and production of oil and gas in the U.S. adds to domestic supplies and possibly keeps prices down, therefore, leaving Americans with more money to spend elsewhere.
Importantly, despite the various tax benefits afforded to energy companies often decried by major media outlets, energy companies pay significant taxes, many of which are allocated to the regions in which they operate.
Earlier this year, The DI Wire reported that natural gas producers in Pennsylvania contributed over $224 million to communities in that state.
“Shale energy production is generating huge revenues for Pennsylvania – in addition to driving job growth,” said Stephanie Catarino Wissman, executive director, API-PA in an earlier report. “Pennsylvania has collected more than $220 million dollars from shale development fees for 2013 production. That translates into better roads, better housing, and better services for families and communities across the state.”
Housing, rent rates and construction, enjoy the benefits of energy booms as well.
In Williston, North Dakota, which sits atop the Bakken Shale, a large oil formation, the population has doubled in nearly four years. Landlords have been able to raise rents due to increased demand and a supply shortage. As reported by The DI Wire in early 2014, a 700 square foot entry level apartment in Williston rents for $2,394 a month, as compared to $1,504 in New York according to a survey by Apartment Guide.
In addition to these regional benefits, domestic production brings the country theoretically closer to the ever elusive goal of energy independence.
Understanding Direct Energy Programs
There are several key differences in direct energy programs.
A program may be public or private. It could focus on exploratory or developmental drilling. Sponsors may focus on certain geographic or geologic areas while others may diversify within an offering.
We’ve only scratched the surface, but thankfully, there are many organizations that assist in understanding the differences amongst direct energy programs.
The IPA provides several resources aimed at educating broker-dealers, advisors, and investors on the details of energy programs.
“We work with our member firms to develop education and training programs and content that help raise the awareness for direct energy products, both at the investor level and advisor level,” says Hogan.
There are 18 sponsors of oil and gas related offerings. For a complete list, visit The DI Wire’s directory of oil and gas firms here.