With the growth in oil and gas exploration and production in recent years, oil and gas partnerships have become an increasingly popular investment vehicle for accredited investors. These partnerships allow individual investors to participate in oil and gas projects that would otherwise only be accessible to large corporations or institutional investors. Oil and gas partnerships investments are typically offered through private placement memos (PPMs) targeting high net worth individuals. By reviewing the PPM thoroughly and conducting proper due diligence, investors can better understand the risks and rewards associated with investing in a particular oil and gas opportunity.
Understanding how oil and gas partnerships work
Oil and gas partnerships are structured as limited partnerships, with a general partner who manages the operations and limited partners who contribute capital. The general partner is usually an experienced oil and gas company with expertise in exploration and production. The limited partners are passive investors with limited liability. Profits are distributed to partners based on their ownership percentage. Investors can benefit from tax advantages like deduction of intangible drilling costs and depreciation. However, they also take on significant risks if projects fail to produce as expected. Conducting thorough due diligence on the general partner’s track record and the viability of projects is crucial.
Reading the PPM to evaluate partnership terms
The PPM contains detailed information about the partnership’s strategy, management team, risks, conflicts of interest, fees, expenses, tax treatment, capital requirements, distribution policy, exit strategy, and more. Investors should carefully analyze the partnership’s objectives, proposed projects, estimated costs, production timelines, decline rates, pricing assumptions, risk factors, and track record. Higher fees or promotional interests for the general partner can reduce potential returns. The exit strategy and ability to liquidate holdings are also key considerations.
Understanding partnership risks and mitigations
Oil and gas partnerships carry substantial risks, including volatile commodity prices, drilling risks, production uncertainties, environmental concerns, and liquidity constraints. Investors should assess the partnership’s risk management strategies, diversification of projects, hedging policies, insurance coverage, and asset base. Partnering with operators who have strong technical expertise and a record of successful projects can help mitigate risks. Investing in partnerships with a portfolio of assets at different stages can reduce concentration risk.
Conducting due diligence on the general partner
Thorough due diligence on the general partner is essential, including assessing their track record, management team qualifications, financial strength, reserve valuation policies, relationships with operators, hedging strategies, governance policies, and more. Background checks on key executives, site visits to existing projects, and reference calls can provide additional insights. Investors should verify that the general partner’s interests are well-aligned with limited partners through co-investment and incentive structures.
Understanding liquidity options and exit scenarios
Liquidity is typically very limited in oil and gas partnerships, as interests are not publicly traded. Investors rely on periodic distributions and eventual disposition of reserves or partnership interests for returns. The PPM should provide information on potential exit scenarios, such as an IPO, merger, asset sale, or redemption of units. Realistically assessing the viability of these options and the timeline to exit is important. Some partnerships have built-in liquidity features like redemption plans, but often with restrictions and penalties.
Oil and gas partnerships can provide attractive returns for accredited investors but also involve substantial risks. Carefully evaluating the PPM, conducting due diligence on the general partner, assessing risks, and understanding liquidity options allows investors to make informed investment decisions regarding these complex investments.