A SIMPLE GUIDE TO SAFER OIL & GAS INVESTMENT

 

Oil and Gas investment has always been risky business. For over a hundred years, the business has been a continuous cycle of booms and busts. In my nearly 42 years in this industry, I have seen six or seven of these cycles, and lived through several more growing up in northeastern Ohio. Witnessing these cycles, working through them, and surviving in the energy business has taught me a lot.

 

When I entered this industry in 1980, the economic conditions were much like today. Inflation was at a record high, as were energy costs. Deep natural gas found below 15,000 feet had been deregulated. Drilling was at unseen before proportions, while even a windfall profits tax on production was installed. Borrowing for energy development skyrocketed until the infamous Penn Square Bank collapse changed the banking industry on energy lending.

 

Today, many things are the same, but some things are a bit different. Driven by high gasoline, diesel, and natural gas prices, inflation is at a 40-year high. Coming out of the pandemic, demand has dramatically outpaced supply. National energy independence is no longer. Lack of exploration and production has contributed to our domestic reserve shortages and decreasing supplies. As of April 15th, natural gas storage supplies were down 22.6% from that time last year.

 

Unlike the past, when pricing spiked and led to the sector’s recovery, drilling and production activity have not yet returned. The daily drilling rig count is still less than half of pre-pandemic numbers (695 nationally and 51 in Oklahoma).  New leasing has basically been non-existent, and businesses, service companies and people that once worked in the industry have not yet coming back in very large numbers.

 

What is different this time?

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The reasons for this trend are many.  Lack of energy policy, uncertainty of the future, and the relentless push to eliminate the fossil fuel industry have all contributed to the lack of interest.

 

How do we, as explorers and producers of oil and gas, turn these problems into opportunities?

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What I have learned in the last 40+ years is beneficial in charting our future. The most important points are these:

 

1.         This boom price cycle should last at least four to five years. Unless changes are made, it could be longer.

2.         New energy development starting from scratch takes years and depends on the size the project.

3.         Prices and costs to do everything necessary, have increased at least 25% in the past year alone.

4.         However, oil prices have more than doubled in the last 2 years and natural gas has tripled.

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            Example:         Oil=$54.00/BO two years ago vs $110.00/BO

                                    Natural Gas=$2.50/MCF two years ago vs $8.00/MCF 

            (Note: June futures trading as of 5/24/22)

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OUR GUIDE TO SUCCESSFUL OIL & GAS INVESTMENT

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When investing in energy exploration and development, here is a summary of things you should know:

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I.      KNOW YOUR LIMITS

As always, knowing your investment limits is fundamental. Even though most development prospects are low risk, there is always some risk involved. It is a gamble, but one where the odds strongly favor the investor.

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Only invest amounts you can afford without borrowing. A common mistake made by many companies and individuals is borrowing money to invest while prices were high, only to experience a price drop. This may lead to the inability to service debt and possibly even to bankruptcy.

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II.     PLAYING THE ODDS

Investing smaller amounts in multiple ventures increases your odds of success and minimizes risk. For example, investing in ten smaller ventures is less risky than investing in one large venture of equal value. Why? Because we have been keeping records of wins and losses for over 40 years. We have found that if you were to invest in 10 different wells, you would very likely get the following results:

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• 1 or 2 wells will pay for the entire ten-well investment. These great wells are known as “barn burners.”  

• 2 or 3 will be solid wells and yield good returns on investment.

• 2 or 3 will be average wells and generate moderate returns.

• 1 or 2 will be marginal and pay unremarkable returns.

• And one well, due to bad luck, bad location, mechanical issues, or any one of a variety of other reasons, will be unproductive.

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*We have enjoyed a 90% success rate. Knowing these statistics, and investing accordingly, helps us reduce risk, increase reward, and alleviate financial strain by spreading costs over multiple endeavors.

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III.    ROLL YOUR WINNINGS

A common practice in oil and gas companies is to roll cash flow into future development and ventures. Compare it to rolling a snowball.  You start with a small ball of wet snow, and roll it into a much, much larger ball.

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IV.    PARAMETERS AND GOALS TO SHOOT FOR

Oil and gas pricing paid to the producer is the most important factor in successful energy investment. We always use the following parameters when considering the viability for pursuing a particular prospect:

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1. Our goal is to achieve a payout of a particular well within 12 months from date of first production.

2. Target a return on investment of at least 8 to 1 for the life of the well (most wells have an average lifespan of at least 15-20 years).

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*How wells produce and decline over time is important to understand. Likewise, the history of product pricing and the projections of future pricing play huge roles in determining which prospects to pursue. Today, these decisions to pursue are much easier to make, despite uncertainty of the markets and current geo-political events.

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V.     SUMMARY OF THE AFEC PROGRAM

The objective of the AFEC Program is foremost to strive for domestic energy independence.  As small operators we know our impact on the big picture is limited, but we can still do our part and do in a large way. The following summary shows what we are doing and how we do it.

 

1. Since we collectively own and operate 186 wells and about 50,000 acres of leasehold, we have a large enough central Oklahoma playing field for many low-risk and low-cost future developments.

   • In many cases, existing wells have a vast range of up hole potential and future completion development potential. Importantly, these untapped reserves are considered “proven developed reserves” (proven reserves that exist where drilled wells are already present).

   • Likewise, many of our leases include multiple undrilled locations containing “proven undeveloped reserves” (proven reserves that exist where wells to recover them do not presently exist).

   • We already own our production infrastructure, such as tank batteries, surface equipment, multiple pumping units, flowlines and easements, 3-phase electric power, and (most importantly) strategically located and permitted saltwater disposal wells.​

2. Despite today’s higher costs, our holdings and infrastructure allow us to drill new wells, recomplete existing wells, and carry out well repairs at a much lower expense than our competitors. Because costs are lower during these times of excellent producer commodity pricing, payouts are faster, and ROIs are greater.

3. Our decades of experience, track record, and methods give us extreme confidence in our ability to commercially produce our wells. Based on average monthly pricing, we have been able to accurately complete economic projections to predict payouts and ROIs. Long-term projections can be less predictable. Using conservative guidelines and formulating multiple backup plans for each project helps ensure our success. Investing in oil and natural gas is never without risk, but our guidelines provide a measure of safety and peace of mind that does not exist elsewhere.

   • Existing well fixes and recompletions will be proposed on a 50/100 formula. Participating partners will pay 100% of the costs to earn 50% of the working interest. Many of these fixes will have minor repair costs and will usually be proposed in a multiple-well package where necessary infrastructure is present and already paid for.

   • Re-entry/washdowns are generally about 60% of the cost of a new well and will be proposed on a 75/100 formula. Participating partners will pay 100% of the costs to earn 75% of the working interest.

   • New wells will always be proposed on an 87.5/100 formula with the AFEC partners retaining a 12.5% carried working interest.

   • In all cases, the AFEC partners and current Operator will retain certain percentages of working interest.

   • Finally, to minimize risk, most prospects will be proposed as multiple-well prospects. Proposals may also be a combination of some or all of the above scenarios.

 

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