Wednesday, April 16, 2008

Part 2 of Steps involved in a typical oil and gas drilling venture/investment – Structuring and funding the partnership

This is the second article in a series that will provide an overview of a typical oil or gas drilling venture from beginning to end (payment of investors). In the last article, we covered scouting a location for drilling through paying off the mineral rights lease holders and the land owner to drill a prospective well. The last article can be read here. The next article can be read here.

Setting up the oil and gas "investment" for investors to participate:
At this point the oil producer has secured rights to drill a specific location. At some point in the process, the producer usually hires a lawyer to set up a general partnership for selling ownership shares to investors. The producer also has the lawyer draft a private placement memorandum (PPM) for prospective investors. The PPM is required by the Securities and Exchange Commission (SEC) when selling partnership interest to new investors. The PPM is required to provide as much information to prospective investors as possible about the viability of the well, the track record of the producer and its principle associates, how the invested funds will be spent, and other details needed to make an informed decision. Information supporting the viability of the well can include information about where it is, how well nearby wells are producing, and other data used to support this as being a good prospective well such as a geologists report, seismic data, logs from nearby wells, etc. The SEC usually restricts these types of investments to accredited investors under the assumption they are more capable of making a sound investment decision than the general public.

As mentioned, these projects are usually structured as a general partnership with each partner having both a working interest and net revenue interest in the well. These relate to your associated tax advantages and net income from the well.

Let’s look at an example to better illustrate working interest and net revenue interest.
In this example, we have a $1M total cost to drill a well that is expected to generate gross partnership income of $100k per month. The partnership sells a 1% working interest in the project for $10,000, which is 1% of the $1M total cost. For this example, this 1% working interest will provide a 0.75% net revenue interest which means you would receive 0.75% of the total partnership $100,000 monthly income or $750 per month. Over twelve months, your total income for the first year will be $9,000 for your $10,000 investment. That translates into a 90% return on your investment in the first year. In reality, there are usually other costs taken out of your income to pay your share of the management fees, oil pump related costs, and other costs. Also, the other 0.25% NRI is paid out to the lease owners, land owners, developer, and possibly others.

Considering liability exposure:
One concern about investing in a general partnership is the spread liability exposure of all general partners. In the case of oil drilling ventures, the only period of any real liability exposure is during the drilling of the well. The partnership usually contacts with the driller to take liability during this period. The driller usually covers this liability exposure with insurance. Once the well is completed and online, the liability exposure is almost nonexistent through the production life of the well.

Next article in the series:
In the next article, we’ll cover details about drilling the well.

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Copyright 2008 Ole Cram. Ole Cram is President of Marcobe Investments, Inc., a corporation that invests in various oil and gas ventures and refers accredited investors, investment managers, financial advisors, investment funds, and others to the associated oil producer of these projects for their consideration to also participate. Feel free to email us at with any questions, thoughts, or requests for information on what projects we are invested in.

This article was posted at Accredited Investor Blog: Past articles can easily be found at This article is provided for educational purposes only and is not meant to be a substitute for tax, legal, financial, or other registered professional advice for your specific situation. Always seek the advice of a professional before making any related decision. Sphere: Related Content

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