Rising oil prices are attracting attention, but energy-related investments call for caution.
Spurred by political turmoil in the Mideast, oil prices reached a 29-month market high of $106.95 a barrel last week. Analysts warn that the runup may be a temporary spike in a volatile market. Oil and energy stocks, index funds and exchange-traded funds, as well as oil futures, all have the potential for a massive correction. The price boom also draws
“unscrupulous promoters,” , said the North American Securities Administrators Association, a consumer protection agency.
Most oil and gas investment opportunities are legitimate, but con artists who “moved onto more lucrative ventures since the oil boom ended in the mid-1980s” have made their way back to oil and energy scams, said NASAA in a recent Investor Alert.
“When there is a highly publicized economic circumstance, which creates an opportunity for money to be made legitimately, scamsters follow in the shadows to take advantage of the situation,” the Alert said.
Fradulent oil and gas deals are frequently set up so that a partnership exists in one state, the oil field is located in a second state and prospective investors live in yet other states. That creates less of a chance that investors will drop by a well site or nonexistent company headquarters, and also makes it difficult for enforcement officials and victims to identify and expose the fraud,” NASAA said.
Oil and gas investments can take many forms, including limited partnerships and general partnerships.Tax consequences and investor liability vary with investment type. A general partner, for example, is personally liable for partnership debts. A drilling limited partnership typcially charges an upfront fee of about 15 percent of the investment and offers a share of revenue. The investor can often deduct the “intangible drilling costs” from taxable income and receives quarterly distributions of oil and gas sales until the wells run dry.
“Drilling partnerships have always been a gamble, but recently, they have proven somewhat riskier than usual,” NASAA said. “This type of investment is very speculative, is a highly illiquid investment and can have a long holding period.”
Fraudsters typically use the Internet and phone banks manned by salespeople with little or no experience in energy exploration, NASAA said. Tactics include repeated unsolicited phone calls that hype the profitability of the deal. Be particularly suspicious of the following claims in a typical high-pressure sales pitch:
• You will have an interest in a well that cannot miss;
• A geologist has given the salesperson a tip;
• The promoter has “hit” on every well drilled so far;
• There has been a tremendous “discovery” in an adjacent field;
• A large, reputable oil company is operating in the area;
• Only a few interests remain to be sold and you should immediately send in your money in order to assure the purchase of an interest;
• This is a special private deal open only to a lucky chosen few.
To avoid being swindled the NASAA recommends:
• Consider oil exploration and producing companies that are well-established and listed on the New York Stock Exchange.
• Resist pressure to make hurried, uninformed decisions.
• Ask about the registration requirements for the investment offering. Find out if the offering is filed with the state securities commission in your state or the state in which the promoters are located. If so, contact the agency for any available information. The salesman may claim the offering is exempt from registration requirements. Contact the state to confirm the offering is exempt and why.
• Question the salesperson to learn his or her name, his location and his background in oil and gas ventures. Ask what his commission or other compensation will be. Contact the state to find out whether the salesperson has previously violated security laws.
• Research the company. Ask the names of the principals of the company, or the general partners involved. Learn their backgrounds and experience in the oil and gas industry. Find out how long they’ve been with the company, and the company’s history, capitalization, assets and retained earnings. Verify that the tax advantages promoted by the company are supported by the Internal Revenue Service. Ask how many wells the company has drilled and the number that became producing wells. Did the company retain its interest in the wells it drilled? Ask for the prospectus of “offering documents” the promoter is required to furnish. A good prospectus will answer your detailed questions.
• Make sure your investment funds are kept in a separate escrow account until they are used, so that they won’t be commingled with other funds. Be sure the funds will not be used for other purposes. Ask how much of your investment will go to advertising, salaries and sales commission. Ask what the completion costs will be for each investor. Is the well to be drilled a “wildcat” – that is, in a territory not know to be productive – or in an area of proven oil reserves?
• Get a legal description of the property to be leased for drilling. How and when was it acquired? Ask for a description of surrounding property, including local well completions, and a geologist’s report on the area. Is the lease already in default? Ask for a disclosure of the person selling the lease, the cost of the lease and any relationship between the lease holder and the well operator. Get a written statement that says how deep the well will be and when the drilling is to begin.
• Seek a second opinion. “It is always advisable to seek the advice of a neutral expert before committing your funds to any investment deal,” NSASS said.