Questions to Ask Before Investing in an Oil Deal
For anyone outside the oil business who has been offered a share of a well, a drilling program or a royalty, and who wants to know what to put to the sponsor before sending money. The questions are grouped in the order the conversation tends to go: what you would own, who operates it, the geology and the production estimates, costs and liability, payouts and tax, and last the seller and the offering itself. Securities, tax and liability rules differ by state and country, so wherever a question touches one, ask how it works where the well sits and where you live.
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The questions
Each question, and why to ask it
The interest
What exactly would I own: a working interest, a royalty, or units in a partnership?
Why ask it
A working interest pays its share of the drilling and operating bills and takes a share of the revenue. A royalty takes revenue without the bills, and partnership units give you a claim on whatever the partnership holds. Have the sponsor point to the sentence in the offering document that says which one this is, because costs, liability and tax all follow from it.
Which wells or leases does my money go into, and can I have their names and locations?
Why ask it
A named well on a named lease can be looked up in the public well files that many oil and gas regulators keep. 'Prospects to be selected later' means you are funding the sponsor's judgment instead of a well, so ask who chooses, by what test, and whether you hear before the money is spent.
What is my net revenue interest, and how does it compare with the share of costs I pay?
Why ask it
Get both figures side by side. If you carry 10 percent of the cost and receive 7 percent of the revenue, the gap is going to the landowner's royalty, to overriding royalties and to the sponsor's carried share. Every slice of that gap should come with the name of whoever receives it.
Is this an exploratory well, a development well in a producing field, or a rework of an old well?
Why ask it
The three carry very different odds. A wildcat can pay well or produce nothing at all, a development well next to producers is a narrower bet, and a rework depends on why the old well stopped. If the pitch says 'low risk' about a well with no producing neighbors, ask what that is based on.
How many wells does the program drill, and what happens to my money if the first one is dry?
Why ask it
One well is one roll of the dice. In a multi-well program, ask whether a dry hole's cost is shared across all the wells or whether each well has its own investors. Leftover money is the other half of the question: is it returned, or moved to another prospect without asking you?
What does one unit cost, and what percentage of the well does it buy?
Why ask it
Scale the unit price up to the whole well and set that total beside the itemized estimate for drilling and completing it. The difference is the price of the sponsor's leases, fees and profit, and it should match what the use-of-proceeds table shows. It takes two numbers and a calculator, and it is worth doing before the next call.
Who holds title to the leases, and has an attorney written a title opinion?
Why ask it
Mineral ownership can be split among heirs and old deeds, and a flaw can hold up every payment from a producing well. The document to see is the drilling title opinion, with the date on it. If the lease is in someone else's name, find out when a recorded assignment will put your share in yours.
When do the leases expire, and what has to happen to keep them?
Why ask it
Many leases last a set term and then only as long as the well keeps producing, but the wording is in each lease, so ask to see it. A lease that runs out in a few months explains a rushed drilling schedule. It also means a delay could leave the program holding nothing.
What happens to my interest if the operator sells the wells or goes out of business?
Why ask it
The answer depends on what you hold. An interest recorded in your own name and units in an entity the sponsor controls can fare very differently when the operator is in trouble. Find out where your interest is recorded and what the agreement says about replacing the operator, then have your attorney confirm both.
The operator
Who will operate the wells, and is that the same company that is selling me the interest?
Why ask it
Sometimes the seller is a promoter who buys a slice from an operator, marks it up and resells it. That is not wrong in itself, but it means two layers of pay and a salesperson with no control over the drilling. Get the operator's legal name and ask to speak to someone there.
How many wells has the operator drilled in this formation, and how many of them are still producing?
Why ask it
Experience in another basin counts for less than wells in this rock at this depth. A list by well name lets you look each one up and count for yourself the ones that were plugged early.
Across every program you have sold, including the ones that lost money, how much cash have investors received for each dollar they put in?
Why ask it
A sponsor with a real record has a table: money raised, money spent and money paid back, program by program, with the year each one started. Tax savings should be left out of the figure, which makes it harder to dress up than a rate of return. Missing years or a page of 'our best wells' are the thing to press on, and someone on a first program should say so plainly.
How much of the company's own money goes into this well, on the same terms as mine?
Why ask it
The words to listen for are 'same terms'. Sponsors often hold a share they did not pay for, earned by putting the deal together, which is a different thing from writing a check beside you. Get the dollar figure and the page of the documents where it appears.
Do you or your affiliates own the rig, the service companies or the leases this program pays for?
Why ask it
Dealing with related companies is common in small programs and is not improper in itself. The offering document should have a section on conflicts of interest or transactions with affiliates that lists each one and its price. Where the sponsor is selling its own lease to the program, the follow-up is what the sponsor paid for it and when.
May I call investors from an earlier program, picked by me from the whole list?
Why ask it
References the sponsor selects will be the happy ones. Ask them whether the checks matched the projections, whether there were surprise cash calls and how quickly their questions were answered. If privacy is the reason for refusing, ask the sponsor to forward your request to all of them.
Has the company, or anyone who runs it, been sued by investors, sanctioned by a regulator or been through bankruptcy?
Why ask it
Ask it directly and write down the answer, then search court records and the securities regulators yourself for the company, any earlier names it has traded under and each person. An old dispute that is explained calmly is survivable. One you find after being told there was nothing is the end of the conversation.
Does the operator have open violations or idle, unplugged wells on record with the oil and gas regulator?
Why ask it
Regulators in many producing regions publish inspection and compliance records by operator name, so ask which agency covers this well and look. A trail of idle wells nobody has plugged shows how the company treats its obligations once the income stops.
Geology and estimates
Who prepared the geology and the reserve estimate, and are they independent of the sponsor?
Why ask it
A report by a petroleum engineer or geologist with no stake in the sale carries more weight than one written in-house. Read the full report, with its author's name and its date, instead of a summary page. Then check that the well in the report is the well you are being sold.
What evidence puts oil or gas at this location: seismic, logs from nearby wells, or production from the same zone?
Why ask it
The three are not equal. A neighboring well already producing from the target zone is the most direct evidence, while seismic mostly maps the shape of the rock and says less about what is in it. The useful follow-up is how far away the nearest well that tested this zone is, and what it found.
What are the nearest producing wells making today, and can I see their production month by month?
Why ask it
Their histories are often public, and they show what this rock gives up over years instead of weeks. Look at what the wells produce now, not what they made in their first month. If the sponsor quotes one standout well, ask about the others around it.
What starting rate do the projections assume, and how quickly do they assume it falls?
Why ask it
Wells produce the most at the start and decline from there, in some formations steeply within the first year or two. A projection that holds the opening rate flat is a brochure, not an estimate. Ask to see the assumed curve laid over the real curves of nearby wells.
What oil and gas prices do the projections use, and what does my return look like if prices drop by a third?
Why ask it
Price is the one input nobody in the room controls. Have the same spreadsheet rerun at the lower price, and find out whether any of the production will be hedged. If nobody has run that case yet, the projections are not finished.
How have this operator's earlier wells here produced, set against what was projected for them?
Why ask it
You are asking for two columns: the estimate given to earlier investors and what the wells delivered. Everyone misses sometimes, so a miss is not the worry. The worry is a comparison that cannot be produced, which leaves you trusting a method nobody has checked.
If the well comes in at the engineer's low case, do I get my money back?
Why ask it
Sales material usually shows the middle case or the high one. Find the low case in the reserve report and have the payout worked on it, after all costs. Then decide whether you could live with that outcome, since the report itself calls it possible.
How does the oil or gas get to a buyer, and is that arrangement in place now?
Why ask it
Oil can usually be trucked, but gas needs a line, and a well waiting on a pipeline connection earns nothing. The details to get are the purchaser's name, whether a contract is signed and what is deducted for gathering and transport before the price reaches you.
Costs and liability
Out of each dollar I put in, how much is spent on the well, and how much goes to commissions, fees and the sponsor?
Why ask it
The use-of-proceeds table in the offering document answers this. Add up everything that is not drilling, completing or equipping the well: sales commissions, management fees, organization costs and marked-up leases all come out first. The more that is taken at the front, the better the well has to be for you to break even.
Can I see the itemized cost estimate for the well, and what have similar wells nearby cost?
Why ask it
The document is usually called an AFE, an authorization for expenditure, and it lists the rig, casing, completion and equipment line by line. Take it to someone who works in the business if you can. A total with no lines behind it cannot be checked by anyone.
Is the drilling price a fixed turnkey figure or the actual cost, and who keeps the difference if the well comes in under budget?
Why ask it
A turnkey price protects you from overruns, and it is also where a sponsor can build in a profit before any oil is found. Ask what the same well would cost billed at actual cost. The wider that gap, the less the sponsor's income depends on the well producing anything.
Can I be asked for more money after I have paid, and what happens if I say no?
Why ask it
Working interest owners can generally be billed for their share of extra costs: a completion, a repair, a second attempt. The operating agreement says what refusing costs you, which can be a penalty taken out of your revenue or the loss of the interest. Read that clause before any other.
If the well is drilled and looks marginal, who decides whether to spend the completion money?
Why ask it
Drilling the hole and completing it for production are two separate bills, and the second decision rests on logs and tests you will not be able to read. Find out whether investors vote, who advises them, and whether the operator earns a fee on the completion either way.
What will the well cost to run each month once it is producing, and who checks the operator's bills?
Why ask it
Pumping, power, hauling off the salt water that comes up with the oil, repairs and the operator's overhead charge all come out before your share. A monthly operating statement from a comparable well shows the real figure. On the second half, the thing to learn is whether investors have the right to audit the joint account and whether anyone ever has.
What does the sponsor take from production, and does that share grow after I have my money back?
Why ask it
Look for an overriding royalty, a management fee and a 'back-in', where the sponsor's share steps up once investors reach payout. A back-in can be a fair reward for a good well. Ask for a worked example of your share of one month's revenue before payout and after.
Who pays to plug the well and restore the site at the end, and is money being set aside for it?
Why ask it
Every well ends with a plugging bill, and for working interest owners it can arrive after the income has stopped. Three things to pin down: the estimated cost, whether it is in the projections, and whether a reserve is held back from revenue. 'The salvage value covers it' deserves a number.
Could I owe more than I invested if there is a blowout, a spill or an injury on the lease?
Why ask it
It depends on how you hold the interest. Some programs bring investors in as general partners while the well is drilled, for tax reasons the sponsor will explain, and convert them to limited partners afterward, and during that window your exposure may not stop at what you put in. Take this one to your own attorney, who can say how liability works for this form of ownership in the state where the well sits.
What insurance does the operator carry, with what limits, and am I covered by it?
Why ask it
The answer should arrive as certificates and not as a description: general liability, well control and pollution cover are the ones that matter here. Check the limits against the kind of accident a well can have, and check whether investors are named as additional insureds.
Payouts and tax
When would the first check arrive, how often after that, and what paperwork comes with it?
Why ask it
Count from the day you wire: permitting, drilling, completion, hookup and the purchaser's first payment cycle all sit in between. Ask what the gap was on the sponsor's last well. Each check should come with a statement of volumes, prices and deductions, and you should know which tax forms arrive each year and by what date.
How many months until I have my original investment back, and is that before or after operating costs?
Why ask it
A well produces less each year, so money that has not come back early may not come back at all. Have the months counted from the day you wire, not from first production. Then ask how long payout took on the sponsor's last few wells, which is a record and not a forecast.
Can I see a real revenue statement from one of your producing wells, with the owner's name blacked out?
Why ask it
One page shows what an explanation cannot: the volumes sold and the price, then royalties, production or severance taxes where they apply, transport and marketing charges and operating costs, down to the amount of the check. Compare the top line with the bottom one. On a real well, that ratio is a fair guide to what a dollar of projected revenue turns into.
What will I be told while the well is being drilled, and can I visit the site?
Why ask it
Operators usually keep daily drilling reports for their own use, so sending investors a copy is little extra work. Going to the location will not teach you geology, but it confirms there is a rig, a lease road and an operator whose name matches your paperwork. Find out too who takes investors' calls once the well is producing and the salesperson has moved on.
Can I sell or transfer my interest, and has an investor in one of your programs ever done it?
Why ask it
Assume the honest answer is 'in theory'. There is usually no market for a small slice of one well, transfers often need the sponsor's consent, and a buyer pays for the production that is left, not for what you put in. Plan on holding it until the well is plugged.
Which tax deductions does this offering claim, and what do they depend on?
Why ask it
Pitches often lead with writing off most of the investment in the first year through drilling cost deductions, with a depletion allowance on the income later. Whether any of that applies turns on the kind of interest, how you hold it, your own income and the tax law where you file. Get the sponsor to name the rules being relied on, then put the same question to your accountant.
Is there a written tax opinion from someone outside the sponsor's firm, and can my accountant read it?
Why ask it
A tax opinion in the offering document says what its author is and is not willing to stand behind, and the hedged paragraphs are the useful ones. Your accountant should see it before you pay, not at filing time. If the tax story exists only in the sales call, treat it as a sales call.
Leaving tax out entirely, does this deal make money?
Why ask it
A deduction gives back part of a loss; it does not turn a dry hole into a profit. Ask for the projection with the tax column removed. If the return disappears without it, you are being sold a deduction with a well attached.
The seller
Who are you registered with to sell this, and under what name can I look you up?
Why ask it
In many places an interest sold to passive investors is treated as a security, and the person selling it needs a license or a specific exemption. Take down the firm, the individual's name and the regulator, then run the search yourself before the next call. 'We do not need one' requires a reason you can verify.
Is the offering registered with the securities regulator, or sold under an exemption, and which one?
Why ask it
Private drilling programs are commonly sold under an exemption from full registration, which can be perfectly legal and also means no regulator has reviewed the claims. The follow-ups are which exemption, whether a notice was filed and where you can see it. Your state or national regulator can tell you how to confirm it.
Do I have to qualify as an accredited or sophisticated investor, and how will you check?
Why ask it
Many private offerings may only be sold to people above an income or wealth threshold, and the rules vary by place. A seller who waves this away, or coaches you on which box to tick, is showing you how the rest of the paperwork was handled. Ask what the threshold is where you live.
What are you personally paid if I invest?
Why ask it
Commissions on private oil programs can be large beside those on ordinary investments, and they come out of your money on day one. You want a percentage and a dollar amount. A salesperson who is paid only when you wire is not the person to ask whether you should.
How did you get my name and phone number?
Why ask it
Regulators have published warnings about oil and gas interests sold by unsolicited phone call. A referral from someone you know who has invested is a different start from a stranger who somehow had your number. If it was a cold call, do every check in this section twice.
Where exactly does my wire go, and is the money held in escrow until the minimum is raised?
Why ask it
The account should belong to an escrow agent or to the program itself, in the name printed on the offering documents. On escrow, get the minimum raise, what happens to your money if it is not reached and how long that can take. A personal account, or a company with a different name, is a reason to stop.
Why does the well have to be funded by this date?
Why ask it
There can be a real reason: a rig is booked, a lease is about to expire, a partner has a deadline. Ask to see the rig contract or the lease date. A deadline that moves when you hesitate was never about the well.
Will you give my attorney and my accountant time with the offering memorandum, and answer their questions in writing?
Why ask it
The memorandum's risk section is written by the sponsor's lawyers and is usually blunter than the sales call. An attorney who knows oil and gas will go straight to the cash call and liability clauses of the operating agreement. Resistance to either the delay or the writing tells you more than the answers would have.
How to question an oil and gas sponsor before you wire money
Practical guidance for the conversation itself
Before the first real call
Ask for the whole packet
Request the offering memorandum, the subscription agreement, the operating or partnership agreement, the itemized well cost estimate, the reserve report and the title opinion. A program that is ready to take money should be able to send most of them the same week. A slide deck with wiring instructions is a brochure, and most of The interest and Costs and liability cannot be answered from one.
Find the wells in the public record
Ask which agency regulates oil and gas where the well sits, then search its records for the operator's name and for wells near the prospect. Monthly production, plugging dates and violations are often there. Even a short look at those files shows whether the sales call and the record describe the same field.
Search the people before you like them
Look up the company, its owners and the salesperson with the securities regulators and in court records. Do it before the second call, while you have no stake in the answer. It is much harder to go looking once you have started picturing the checks.
Decide what you can lose outright
A single well can produce nothing, and the interest usually cannot be sold. Settle at home on a sum whose total loss would not change your plans, and do not let a minimum subscription move it. If the minimum is above your number, the deal is too big for you.
Talking to the sponsor
Follow the groups in order
Start with what you would own and finish with the seller. Each group leans on the one before it: the cost questions mean little until you know whether you hold a working interest, and the tax claims depend on both. The exception is a call from a stranger. Then run The seller group first, because the rest is wasted effort if the person and the offering do not check out.
Ask where each number came from
For every rate, price, cost or return, ask which document it is in and who wrote that document. In your notes, mark the figures that come from an independent engineer's report apart from the ones that come from the sales team.
Get past the salesperson
Ask for twenty minutes with the operator's engineer or geologist. You do not need to follow every term. You are checking that such a person exists, knows this well and gives the same account of it as the person selling.
Keep tax out until the well adds up
Go through the well, the costs and the payout before the deductions come up, which is why the tax questions sit at the end of their group. A sponsor who keeps steering back to this year's tax bill is showing you which part of the offering is strongest.
Have the answers confirmed by email
After the call, send your notes back as a numbered list and ask the sponsor to confirm or correct each line. Promises about cash calls, fees and payout dates are worth something on paper and very little from memory.
Checking the deal on paper
Cost share against revenue share
Write down the share of costs you pay and the share of revenue you receive, then divide the second by the first. The further below one that figure sits, the more of the well other people own without paying for it, and the more oil it has to produce before you are whole.
Rerun payout at the low case
Take the low case from the reserve report, a lower price than the sponsor used and the operating costs from a real statement. Work out how many months of checks it takes to add up to your investment. If that is longer than the well is likely to last, the base case is carrying the whole offering.
Lay the curve over the neighbors
Print the projected production for the first three years beside the public histories of the nearest wells. If the projection sits above every real well in the area, ask what is different about this one, and put the question to the engineer instead of the salesperson.
Add the bills that come later
List what you could still owe after the first wire: completion costs, repairs, your share of a month when the well costs more than it earns, and plugging at the end. Put a figure beside each from the cost estimate and the operating agreement. The real size of the investment is the wire plus that list.
Signs to keep your money
A stranger, a phone call and a deadline
An unsolicited call about a well that closes on Friday combines two things regulators' investor warnings describe. Real programs can have real deadlines, and they can show you the rig contract. Nothing about a good well requires you to skip the reading.
Returns with no report behind them
A monthly income figure quoted without a named engineer, a reserve report and data from neighboring wells is a guess with a dollar sign on it. Ask for the report once. If it does not come, stop asking.
The deduction is the pitch
When the first five minutes are about this year's tax bill, the well is the afterthought. Tax treatment can make a sound program better. It cannot rescue a bad one, and it is the claim that depends most on your own circumstances.
Money that goes somewhere unexpected
Wiring instructions to an individual, to a company whose name is not the one on the documents or to an account abroad are a reason to stop. So is any request to pay before the subscription agreement is signed. Call the escrow agent on a number you found yourself.