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How to Recognize (and Avoid) Speculative Oil Investments

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While every investment comes with inherent risk, oil investments are an especially risky business – albeit one with potentially outsized returns.

EnergyFunders seeks to minimize risk by focusing solely on oil investments with reputable operators and conducting due diligence about projects. We choose not to invest in oil deals whose success requires speculation about actions third parties might take (something difficult to control).

Examples of Speculative Oil Investments

Mineral Acquisition Projects

Large-scale mineral acquisition projects are deals in which speculators seek investors to help finance the purchase of minerals from as many people in an area as possible. The speculator hopes that an oil and gas company will target the area for production and the owners of the mineral rights will earn royalties.

These deals are highly speculative because they require a large-scale leasing effort, plus expensive due diligence of minerals purchased.

Secondly, most mineral owners don’t sell interest in their minerals. The last major example of when speculators bought mineral interests in these types of deals was during the Great Depression.

Thirdly, the chance of a speculator – typically without insider geological expertise – identifying a lucrative area where they can purchase minerals cheaply before an oil company discovers them is extremely low.

Royalties in Oil and Gas Leases

Royalty or overriding royalty for leases where the more lucrative formations will be developed “later” are a common source of speculative investments.

The royalty or overriding royalty owner has no control of when drilling will occur on their oil and gas lease. Yet you will sometimes find royalty owners willing to sell royalty interests on leases where the deeper or the more lucrative formations will be developed sometime around the corner.

Questions you should ask include why the more lucrative formations have not already been developed, what guarantees there are for the upcoming drilling program, and why the royalty owner is willing to sell what is purportedly a windfall.

Lease Flipping

Lease flipping is another potentially lucrative but highly speculative deal to approach with caution.

When lease flipping, a speculator leases directly from the landowner in a situation that is similar to a large scale mineral acquisition project. In one case, the lease flipper leases the mineral owners to poor terms and a long primary term and hopes that another oil and gas company decides to drill wells later.

The other type of lease flipping is when a portion of an existing lease – usually at a different depth formation than where production is occurring – is purchased and marketed to other companies seeking to consolidate a leasehold position at that formation.

These types of deals require an exceptionally strong understanding of market conditions in a particular area, and the investor must rely on the speculator’s skill.

How to Avoid Speculative Oil Investments

There are many variations of speculative oil investments that you should approach with caution. The common theme in all of them is that they require another oil company to see value and act on that value – where they have no obligation to the investor to do so – for the investor to profit.

That’s why EnergyFunders uses the equity crowdfunding model – we only make a profit when you do so we have a vested interested in selecting the best deals where everyone wins.

Create a free account to view our current vetted oil investments or learn more about 11 Major Mistakes to Avoid in Investing in Crude Oil.