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Oil and Gas Private Offerings - Risks - What Could Possibly Go Wrong?

Boca Raton, Florida Oil and Gas Private Offering Litigation and Arbitration Attorney:

What could possibly go wrong with an oil and as private offering?

The oil and gas industry is often in the news.  Because of this, some people have used the appeal of "striking it rich" with a gushing well as a basis for fraudulent schemes.  The SEC and the states have brought a number of cases involving "great opportunities" that turned out to be scams. Investors lost some or all of their investments.  Many scams shared the same themes.

Investing to support drilling and completion operations.  The SEC has investigated many oil and gas offerings that claimed they were about to strike oil or gas and they just needed some investment to pay for drilling and completion. The promoter often doesn't tell you, however, that he owns the drilling company or plans to hire a driller at far less than what he's told you the drilling costs will be while pocketing the difference. The promoter makes money from you even if the well comes up dry.

Undisclosed use of proceeds.  In several cases, the SEC alleged misrepresentations about what the invested funds were going to be used for. Misrepresentations and omissions about uses of investors' monies included (i) paying big sales fees to brokers, (ii) the nature and size of compensation to the promoter and employees of the venture, (iii) operating and other expenses for unrelated businesses and (iv) using the money to pay for personal items.

Overinflated or misrepresented prospects and claims.  One common thread among all fraudulent schemes, including those related to oil and gas, are claims that they are about to strike it rich, or that it is likely or even guaranteed that the returns will be too good to pass up. When you hear this sales pitch, you should be very skeptical about high returns with little risk that are just around the corner. Higher returns typically mean higher risks of loss.

Common red flags:

• Sales pitches referring to recent news events like high oil or gas prices.

• "Can't miss" wells and "guaranteed" returns, including claims that major oil and gas companies are drilling nearby.

• Abnormally high rates of return.

• Unsolicited materials.

• Sales tactics that pressure you to decide, like "limited" or "once-in-a-lifetime" opportunity.

• Sales pitches touting new technology, especially if it relates to getting higher production out of low-producing wells (sometimes called "stripper" wells).

• Salesperson claims to be an investor.

• Being asked to sign documents acknowledging that the securities laws do not apply to the investment.

What should You ask?

Analyzing an oil and gas investment may involve highly technical matters, such as geological findings and new drilling technologies, making it difficult for many individual investors to fully understand.  Also, the only information that you have may be coming from the promoter. You may receive a private placement memorandum detailing the venture's management, its drilling prospects and plans, the terms of the venture and investment, and basic financial statements for the usually new venture.  As a start, if you aren't given anything in writing, then you should be very skeptical.

You should ask questions until you are satisfied with the answers.  Don't just accept promises of low risk for high returns.  Remember, it is your money and you shouldn't let anyone pressure you into purchasing an investment that you don't understand.  Here are some things to ask about and consider if you're thinking about investing in an oil and gas venture:

  1. Use of proceeds. What is my money going to be used for? Can you estimate how much of the money you raise will be used for each of your needs, such as drilling operations, administrative overhead and broker sales fees? If sales fees will be paid, how are those fees calculated? It is reasonable to expect the company raising the money to have plans for it, particularly if the persons involved have prior industry experience. Otherwise, why are they raising that specific offering amount? If broker sales fees are being paid, you should know that registered brokers are subject to rules and regulations including the amount of sales fees they can charge.
  2. Related parties. Are you hiring another company to drill or do any other work? Is there any relationship between these companies and the promoters and principals in the venture? How much is the promoter going to make even if we drill a dry hole? Remember that the persons involved in the offering can do quite well for themselves when the investment funds are used, for example, to pay themselves or to hire a company they own to do the drilling. They get paid even if the well is dry. Remember too that a promoter who makes his money on the front-end of a deal-that is, from selling the investment to you and benefiting from the proceeds-rather than on the fortunes of the venture-namely the actual production from the well-does not have the same interest as investors like you whose only hope to gain is from a successful well. You should be wary of any oil and gas investment where the promoter's interests are not aligned with yours.
  3. Prior experience. What is your track record in the oil and gas industry? Have you had experience with this particular well location? In some cases brought by the SEC involving oil and gas offerings, the promoters have claimed extensive prior experience and success in the industry. These claims were made to stop investors like you from asking questions. Instead, you should try to independently verify any claims. Ask for references.
  4. Well history. Is there a prior history of drilling where you are drilling? If someone drilled there before, how much did they get out and what makes you think you can get any more out? If the area proved dry before or has not been drilled, why do you think there's something there? A lot of new oil and gas is found in the United States today because of improved ways of drilling, such as hydraulic fracturing (i.e., fracking) and horizontal drilling. These improvements often require specialized expertise and may cost a lot.
  5. Third-party report. Did you get a third-party engineering report for the site? Can I see the report? Some operators may employ the expertise of independent third-party engineers and geologists to decide whether it makes sense to drill in an area. If the promoter says there is a report, but doesn't allow you to see it, you may want to consider it a red flag. You should also consider whether the engineer or geologist is truly independent. Promoters sometimes use reports prepared by the same engineers that sold them the project or by engineers they employ or use repeatedly.
  6. Reserves.  If the offering materials discuss reserves, what types of reserves are being estimated? Who determined these reserve estimates? Were they audited or reviewed by an independent third party? Can you review the audit? The use of terms such as "reserves" makes it sound like a sure thing. However, reserves in the oil and gas industry are not so certain and can vary a lot. Reserves can be "proved," "probable" or "possible." Proved reserves are relatively certain. Probable and possible reserves can mean, in short, a 50% to 10% chance of extracting the estimated amount. Though not required, some oil and gas ventures do have their reserve estimates audited.

Keep in mind that if the investment opportunity is an outright fraud, the written materials may look legitimate and every question you have about the opportunity may be answered to your satisfaction, but that doesn't make any of it true. It is important to conduct your own independent research. One good way to do that may be to engage an investment professional specializing in oil and gas.

Please keep in mind that the above is being provided for educational purposes only.  It is not designed to be complete in all material respects.  If after reading this post you have any questions, you should contact a qualified professional.

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