Investing in crude oil is hard enough without making rookie mistakes.
If you’re reading this, you’re likely an expert in your field and looking to expand your income-generating portfolio.
While it can be a lucrative way to step out of the standard 5% ROI real estate investments that you’ve been relying on in this low-return market, it helps tremendously to know the potential pitfalls before graduating to the major leagues and making that first investment.
In that spirit, here is our checklist for a new oil and gas investor.
Get reading, rookie.
1. Not Having a Partner Whose Interests Align with Yours
The biggest reason investing in crude oil is loaded with pitfalls is because of the abundance of bad deals floating around in the market.
You need to partner with someone who knows the oil and gas industry and who isn’t making commission just from putting your dollars into a project.
Your first step is finding a knowledgeable partner who is genuinely concerned with weeding out the bad opportunities and presenting only good opportunities.
This is what we do at EnergyFunders. But if you don’t go with EnergyFunders, work with someone knowledgeable.
Spending time combing through bad projects and cherry-picking the good ones is a full-time job that you likely can’t commit to if you are generating the income needed to invest.
Every oil and gas investor needs a good partner.
2. Walking Away When Oil Prices Are Low
If you snatched up undervalued housing stock in 2009, you’re probably glad you did.
Oil prices can be low, but investing in crude oil can still be lucrative, especially small projects.
Small operators can acquire assets in bankruptcy sales, lease in areas not in a major shale play, or re-work existing wells already drilled to total depth. All of these are cost-saving benefits that can make projects economical in lower price environments.
Don’t walk away when prices are lower. In that environment, the oil and gas investing herd completely disappears and investment dollars are harder to come by.
This means that there are some great deals for you.
3. Thinking “Do I Really Need a Good Contract?”
So, you’ve got a good deal and you trust your partner.
Let’s just get this done?
…Not so fast.
You still need a contract to protect your interests. A good oil and gas transactions lawyer is crucial to your investing strategy. Each oil and gas deal is unique, and you need to enter the transactions that will yield the most revenue while building in contractual clauses to ensure you get the benefit you’re paying for.
Suppose you pay to drill a well to total depth with an option to complete the well at total depth. The drilling part is 90% of the costs and the completion is 10% of the costs. Your contract gives you the right to participate at the deepest formation. So you drill down to total depth and it turns out that the deepest formation isn’t productive and a shallower one is going to give great returns. Too bad you skimped on a lawyer and you end up paying 90% of the up-front costs without getting any returns.
Pay for a good contract, or use EnergyFunders, which is founded by lawyers and just takes a small carried interest in successful projects.
4. Not Diversifying Your Investments
Your mother told you not to put all your eggs in one basket. While she probably got that gem from life experience, she might as well have gotten it from the business model of any major oil company. Large companies diversify in projects all over the U.S. or worldwide.
The U.S. offers a stable political environment that protects private property rights. It is also the only country in the world where minerals are owned by individuals, meaning there are lots of opportunities for investment and deals are abundant.
However, there’s always risk of a dry hole or production that is less than desired, so you should diversify.
5. Letting a Brochure Satisfy Your Due Diligence
Brochures can be slick. But the skill set required to put together a brochure has no correlation with the skills necessary to put together a strong crude investing package.
If you’re savvy, you realize that sometimes the projections in the brochure are rosy at best. Sometimes the best projects don’t even have a brochure and it’s up to you to put it all together. We are big proponents of a DIY outlook to investing in crude oil.
We’re also big on transparency, which most brochures don’t come close to giving you. If a deal isn’t transparent, you have to be willing to walk away.
6. Not Understanding the Deal Structure
When oil and gas investing, you have to understand the deal structure. That can’t be emphasized enough.
There are potentially endless twists to the deal structure and you need to read the contracts and the assignments to understand the motivations of the different parties, what your stake in the deal is and what your partners’ stake in the deal is.
Sometimes oil and gas folks like to make complicated deal structures. Take the time to learn the structure and understand why the structure is what it is. Then, if you like the deal, go with the flow (no pun intended).
7. Getting Ripped Off on Percentages
Understanding the deal structure is key to not getting ripped off on percentages.
What’s typical is for oil and gas investors to receive an ownership percentage as close as possible to their share of costs.
It’s also pretty typical for investors to carry the operator for some portion of the costs. For example, the classic deal was called “third for a quarter,” but it’s rare to find deals like that now.
Sometimes companies offer investors deals that aren’t really a good deal. For example, if someone tells you to finance all of the costs of a well for a small overriding royalty interest, you should probably stay away from that. That’s just our opinion, but there are generally better deals, no matter how lucrative the returns might be for such a small interest.
Not holding out for fair deals is a major league mistake in oil and gas investing.
8. Not Educating Yourself on Crude Investing
It wasn’t until he put on his glasses that Ricky Vaughn started striking out batters left and right and got the nickname “Wild Thing.” Just as Ricky Vaughn got ready to play, you can’t be a strong oil and gas investor until you take the steps to get educated in crude oil investing.
Part of the process of understanding the project is to educate yourself on oil and gas risks and disclosures.
You need to educate yourself on the details of the project you are thinking about participating in. That means reading all of the materials available, listening to or watching the webinars and asking the questions pertaining to individual investments that you know to ask because you’re educated on the big picture.
9. Thinking “I Have Real Estate Experience [or insert unrelated expertise here] and Oil and Gas Is Pretty Close”
Investing in crude oil requires a whole new way of thinking.
You’re dealing with an asset beneath the surface of the earth.
When you drive by an oil field, you might just see some beat-up trucks and pump jacks spread around. The value, though, might be in the massive river of oil thousands of feet below the beat-up trucks and ancient pump jacks.
Our way of funding projects and calculating return potential is completely different from what you’re used to.
So, that’s major league oil and gas investing mistake number nine: being over-confident because you’re at the top of your game in another industry and oil and gas is really pretty close.
It isn’t. Do your research.
10. Not Jumping on the Right Deal
You can’t hit home runs in the dugout.
What you can do in the dugout is get mentally prepared to step up to the plate.
You’ve been applying a lot of due diligence. You’ve been weeding out the bad deals and cherry picking the good deals.
There will come a time when that perfect deal will come up. To get that perfect deal, you’ll need to get off the sidelines and up to the plate.
When you’ve done all your homework (and we mean all of it), take a swing and reap the rewards of your hard work as you round the bases.
11. Looking Only to Avoid Pitfalls and Not to Find Great Deals
The final mistake is you spend so much time focusing on avoiding mistakes that you enter analysis paralysis and you fail to close on some great deals.
If you’ve been paying attention, you might say that this mistake is just like mistake 10 “not jumping on the right deal.”
Well, maybe it is pretty similar.
And, if you have an issue with that, you can write your own list of the 11 major league mistakes when investing in crude oil. We’d love to read it. This being our list, we’ll emphasize it over and over that when you’ve done your homework, then it’s time to close.
Not closing a deal means you can never win at oil and gas investing.
So, that’s the last mistake: not believing in yourself to make the right decision and step up to the plate.
What This Means for You as an Oil and Gas Investor
Investing in crude oil is a numbers game. But, you can substantially improve the odds in your favor by applying stringent due diligence to as many deals as possible and then cherry-picking the great deals.
If you weed out the bad projects and only invest in the good ones, you should start putting some major league points on the board.
You can do this entirely on your own, or you can create a free account to view EnergyFunders’ vetted deals and the due diligence information to accompany them.