10 Red Flags When Trying to Avoid an Oil Investment Scam



All investing involves some form of risk. Oil and gas offerings, however, can be particularly risky. While many oil and gas investment opportunities are legitimate, there are plenty of fraudulent promoters trying to take advantage of increasing interest in energy-related investments. These promoters aren’t always investing funds as promised, often using them to pay personal expenses.


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According to the Securities & Exchange Commission (SEC), fraud cases involving private securities offerings for oil and gas ventures have been increasing in recent years. Since 2006, SEC cases have averaged over 20 a year.


Oil and gas investments assume a number of forms, including limited partnerships, general partnerships and complex lease agreements. These forms vary due to tax consequences and investor liability. To raise money for leasing wells and drilling property, drilling limited partnerships involve the sale of partnership units. In return for a fee amounting to 15-16% of an investment, the promoter offers the investor a tax write-off as well as quarterly cash distributions until the wells run dry.


Although drilling partnerships have been around for a while, they are still highly speculative ventures that are difficult to convert into cash and have a long holding period. There’s also guesswork when it comes to recovering reserves, with the possibility of a sizeable oil or gas reservoir turning out to be only a dry well. This is why it’s so important to be aware of the risks before investing. Avoiding oil investment scams requires paying careful attention and spotting any indicators before you invest.


Before making any financial investments in oil drilling or gas, be sure to protect yourself against being defrauded. Consider the following ten red flags:


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  1. Fraudulent Sales Techniques. An easy way to defraud investors is to set up an LLC or corporation in one state, set up drilling operations in a second state and recruit investors from states other than these two. This makes it difficult for investors to examine either offices or drilling fields. Using a structure that spans a number of states also makes it difficult for law enforcement to uncover the fraud.

  2. E-mail Promotions and Other Unsolicited Materials. Sometimes fraudulent promoters use “boiler room” offices and internet pitches to pressure potential investors. This might involve multiple unsolicited phone calls. If you follow up on an e-mail promotion, high-pressure salesmen who know little about the oil business will press you for a commitment. When these salesmen offer glossy brochures to back up their claims, it’s easy to be fooled by their slick, convincing professionalism. It’s wise to ignore unsolicited investment-related emails, voicemail messages and regular mail.

  3. “Once-In-A-Lifetime” Opportunities. Fraudulent promoters will try to give the impression that opportunities are limited and that only by making an immediate payment can you take advantage of the opportunity. No investment is so miraculous that you should neglect to investigate or perform due diligence. Be wary of any high-pressure tactics that require hair-trigger decision making. It’s your money, and you should never agree to something you don’t fully understand.

  4. High Rate of Return. A promoter claiming substantial returns on the investment may not be entirely honest. Typically, investments with potentially high returns are also very risky. High-risk investments can also earn substantial losses, so be skeptical of the promise of high returns with little risk. Most scams seem like great opportunities that promise a short window to strike it rich. But you should consider whether the opportunity seems too good to be true.

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  6. Sales Pitches Focused on Highly Publicized News. Crude oil investment scams use recent news items, such as high oil or gas prices, to provide context for an opportunity and make it seem more appealing.

  7. “Can’t-Miss” Wells. No investment opportunities are completely safe and should not be pitched as such. If someone is trying to convince you of enormous guaranteed returns, especially because of major oil and gas companies drilling nearby, it’s likely a fraudulent claim.

  8. Confidential Opportunities. If a promoter discourages you from discussing the opportunity with advisors or even loved ones, it is probably unable to withstand much scrutiny. Being told not to research an opportunity is probably the best indication that it’s a dangerous risk.

  9. Your Questions Are Not Answered. If you have a lot of questions, but the promoter fails to answer them, it’s likely the opportunity is a scam. If an opportunity is legitimate, you should expect clear explanations. You should also obtain everything in writing.

  10. Outrageous Fees. Many of these investment scams require exorbitant fees. These investments may also require a large percentage of your investment, if and when there’s any profit. You should make sure that aggregate fees aren’t higher than your expected profits.

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  12. Lofty Promises. Be wary of other lofty claims, such as the following:

  • Risks are low
  • There was a tip from a geologist.
  • The promoter had a hit on every well drilled so far.
  • There was a substantial discovery in an adjacent oil field.
  • A large company is planning to operate in the area.
  • This is a private deal, only available to special investors.

Other red flags include the following:


  • Sales pitches promising new technology used to achieve higher production from low-producing wells (also called “stripper” wells). Improved ways of drilling can be expensive.
  • Being asked to sign documents acknowledging that securities laws don’t apply to the investment.
  • A promoter’s interests are not aligned with yours. This can be the case if a promoter benefits on the front-end, benefiting even if the well turns out to be dry.
  • Being told about a report you’re not allowed to read.

  • How to Protect Yourself From Oil Investment Scams

    Now that you know what to watch for in oil investment scams, you can take the following actions to avoid oil drilling investment scams.


    Read the Contract

    Be sure to carefully read a gas investment contract before signing. There may be fine print that effectively states you’re giving your money away.


    Ask Tough Questions

    Regulators caution investors to ask tough questions when considering oil and gas investment opportunities. It may be wise to consider well-established oil production and exploration companies listed on the New York Stock Exchange.


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    Important questions include the following:


    • Does the requested investment far exceed the actual drilling costs? If there’s a large difference, the promoter may be pocketing this in case the well turns out to be dry. It helps to find out how much money is being raised and why the promoter believes that amount necessary.
    • How much capital goes toward direct costs?
    • Are there any participants without obligation to put money in the deal?
    • Who’s responsible for taxes, and will taxes be paid from investor shares?
    • Is there a royalty interest investment for oil drilling?
    • Where is the drilling location? A satellite photo search will provide evidence of this. You don’t want to find out later that you’ve been investing in a location that doesn’t exist or that’s only a dry hole.
    • Is there a history of drilling in the area? If the area proved dry before, is there reason to believe it’s any different now?
    • Where are the pipelines and how will gas or oil be transported?
    • Who is the operator, and what’s his or her experience with such ventures? How will the operator be compensated?
    • Who makes the decision to complete or abandon a well? And what happens to funds paid from the salvage value of equipment?
    • Have precautions been made to mitigate the risks associated with drilling?
    • What have geologists recommended? In SEC v. Hartmut Theodor Rose, the SEC charged promoters in an oil and gas investment scam that failed to inform people of geologist warnings about the location.
    • Is there a relationship between the promoter and geologist recommending the site?
    • If there are reserves, are they proved, probable or possible?

    If a promoter can’t answer questions like these, or at least help provide answers, you should be concerned about the legitimacy of the opportunity.


    Work With a Registered Broker or Investment Adviser

    Hiring your own registered broker or investment advisor can help you fully assess an investment as well as provide legal protections.


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    Keep in mind that anyone soliciting your investment should be registered, unless a company employee is engaging in limited sales activities. A solicitation from a registered broker or advisor is no guarantee that the offering is sound. You still need to consider the risks inherent in a particular investment as well as the registered broker’s history of selling oil and gas offerings. You should also examine the broker’s current or prior relationship with the promoter or any personal stake in the transaction. You should be aware of any conflicts of interest when considering a broker’s advice.


    A registered broker should perform an independent assessment of an investment, evaluating the venture’s claims and prospects. This independent assessment is also called a due diligence report. You should ask for this report, which can help you make a fully informed judgment about the opportunity.


    Even if written materials seem legitimate, it’s still important to conduct your own independent research. It will be easier to assess claims by engaging your own investment professional specializing in oil and gas.


    Research the Investment

    Fraudulent promoters rely on the fact that people rarely investigate before investing. Many will claim extensive experience and success in the oil and gas industry to earn your trust. You should still perform your own research rather than relying on claimed expertise or promotional materials. Rely on neutral experts, not ones who profit from your investment.



    State securities regulators suggest five areas to examine before investing:


    Registration Requirements

    • You can ask for the company’s registration papers and lease agreements, and also ask when you’ll receive a share of the venture and how taxes will be deducted.
    • If the offering is filed with the securities commission in your state or the state where the promoters are located, you can contact the state agency for information.
    • If the promoter claims an exemption from registration requirements, you can ask the state securities agency if the offering is actually exempt and, if so, what exemptions are claimed.

    Salesperson.

    • A salesperson shouldn’t be hesitant about answering questions if it’s a legitimate offering. You should be able to ask about compensation the salesperson receives and also his or her background in oil and gas ventures.
    • You can also contact the state securities agency to ask if the promoter or salesperson was sanctioned for securities violations. You can find out the disciplinary history of brokers and advisers using the Financial Industry Regulatory Authority’s (FINRA) and the SEC’s online databases.
    • Ensure that the salesperson is licensed to sell securities in your state.
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    Company

    • Find out if the corporation is in good standing by contacting the secretary of state where the company is incorporated.
    • Examine the company’s financial statements on the SEC’s website or contact the state securities regulator. Only the smallest public companies aren’t required to file financial statements.
    • Verify that there are no complaints about the company filed with the Better Business Bureau. If there are complaints, pay close attention to the nature of the complaint.
    • You should find out the names of the principals or partners offering the securities, as well as their background and experience in the oil and gas industry, especially with drilling.
    • How many years have they been in the oil and gas business, and how many wells have they successfully drilled?
    • Did the company retain an interest in those drilled wells?
    • What’s the history of the company: assets, retained earnings and capitalization? Is it financially sound?
    • Does the IRS support the tax treatment of investments?
    • Are there conflicts of interest involving the promoter?
    • Is proper insurance in place?
    • If the answers to the above questions are not in the prospectus or “offering documents,” the promoter must furnish this information.

    Investment

    • Research the investment firm as well as the company you’re investing in. Examine the investment firm’s history of investments and consider whether the investments are credible.
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    • Funds should be kept in a separate escrow account, used only for the purposes specified and not commingled with other funds. Has an escrow account been used?
    • How much money needs to be raised and what’s the cost per fractional interest? How much money will be used for drilling operations, overhead and broker fees? Are there enough funds to cover expected costs?
    • How much of the money raised will pay for salaries, commissions and advertising?
    • If a well has been completed, you should find out the completion costs for each investor and whether investors will be required to pay more money in the future.
    • Is there a tax incentive in the event a dry-hole is discovered?
    • What’s the risk of making the investment? In other words, is the well to be dug where there are proven oil reserves?

    Lease

    • Obtain a legal description of the property where the drilling is to occur.
    • How was the property acquired, and how much money is made from the principal selling a lease to the venture?
    • You should also obtain a description of surrounding property, including other well completions and geologist reports.
    • Does the landowner have a leasehold burden that must be repaid? If so, are all the paying partners bearing their portion of royalties paid to the landowner? Is the lease in default?
    • What’s the depth of the well, and when is drilling expected to begin?
    • Is there any environmental exposure?

    Operator

    • You should also find out what you can about the person selling the lease, as well as any relationship between lessor and operator.
    • You should also review the operator’s contract with the promoter.
    • Is the proposed operator experienced, and has he or she operated in the area before?

    Take Your Time

    When investing in oil and gas, it’s vital to take enough time to make informed decisions based on accurate information. What better incentive to take your time than the risk of losing your entire investment because of hasty decisions?


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    Contact Your State Securities Administrator

    Despite the risk of fraud, oil and gas investing can be a profitable way to invest your money, with payoffs as much as 5 to 1 and, in some cases, as high as 20 to 1. You just need to remember the risks and protect your money by making sure you’re not being scammed.


    If you have questions, you can follow up with our team for a free consultation. You can also contact your state’s securities administrator can provide helpful guidance. You can find your local state securities administrator at the NASAA’s website.


    SEC Complaints

    You can also contact the SEC for complaints about oil and gas investments using the SEC complaint form.


    To illustrate the kinds of scams the SEC has prosecuted, consider the following:


    Undisclosed Usage

    • SEC v. Wellco Energy, LLC - Promoters misrepresented that investor funds should be used for oil and gas when 58% of funds raised went towards sales fees in addition to the promoter’s mortgage and child support payments. Incidentally, the company selling the offering wasn’t registered with the SEC.
    • SEC v. Provident Royalties, LLC – Although investors were made to believe 86% of funds would be gas or oil investments, part of the funds paid dividends to earlier investors. Brokers who sold these offerings were sanctioned by FINRA for not having a reasonable basis for recommending them.
    • SEC v. Petroleum Unlimited, LLC – Only $534,000 of $2.9 million raised was used for oil drilling. Other funds were allocated for undisclosed sales fees and paid directly to the promoter and other related companies. The company selling the offering wasn’t registered with the SEC.

    Inflated Claims

    • SEC v. Harmut Theodor Rose – Promoters misrepresented the success of prior wells to raise funds for new wells that were dry, claiming the opportunity was “once-in-a-lifetime” and “low-risk.”
    • SEC v. Petroleum Unlimited, LLC – Investors were told they would receive returns of anywhere between 14% to 141% a year. However, 81% of the money was allocated toward sales fees.
    • SEC v. Hilton – The promoter in the case inflated the prospects of the wells as well as the expected returns.

    Inflated Experience

    • SEC v. Sunray Oil Co. – Although the promoter claimed that Sunray had 50 years of experience, the company was a fairly recent one.

    False History

    • SEC v. Hilton – The promoter falsely claimed that Exxon Mobil previously drilled the well but abandoned the field due to technological shortcomings.

    SEC cases often involve hundreds and even thousands of investors, with the Provident Royalties case involving an $85 million fund amassed from 7,700 investors. With fraud impacting so many people, it’s important to consult with experienced oil and gas professionals who can help you avoid scams.


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    Consult With Oilscams.org

    With 40 plus years of collective oil investing experience, the oil and gas professionals at oilscams.org can show you how to avoid oil investment scams. We have a strong D&B PAYDEX listing along with a solid credit history and oil investor references. Be sure to consult with our investment experts at oilscams.org before making an oil or gas investment. Using our free educational tools, you should be able to invest with greater confidence and a full understanding of any potential investment.



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