Crowdfunding comes to the oil industry – file under what could go wrong

The great thing about capitalism is its flexibility. If an idea has the potential to generate an attractive return for investors, you can be pretty sure that in a free capitalist market someone will come up with a way to get around all of the obstacles standing in the way of the project and realize its lucrative returns.

This is exactly what’s happening in the oil industry right now. Low oil prices have decimated the industry, but now the industry is adapting to the new environment.

An end to the boom times 

During the North American tight oil boom, companies of all shapes and sizes rushed to get a piece of the action. When times were good, every firm that entered the space was effectively given a license to print money. However, to paraphrase Warren Buffett, when the tide went out it has quickly become apparent which companies were swimming naked, with unsustainable levels of leverage, complex operating structures, and inferior resource reserves.

During the past two years, the North American oil industry has been undergoing a rebalancing. The worst operators in the oil space have collapsed into bankruptcy, while the strongest have used the downturn to apply pressure to suppliers lowering costs and upgrading technology increase the efficiency of existing wells.

As I reported a few weeks ago, according to law firm Haynes and Boone LP’s Oil Patch Bankruptcy Monitor as of August 1, 2016, 48 producers have filed bankruptcy so far this year, with approximately $49.3 billion in cumulative secured and unsecured debt. After a relatively subdued start to the year, April turned into a blood bath for struggling oil companies and their creditors as 18 North American oil and gas producers filed for Chapter 11 listing $14.9 billion in debt, more than any other month covered by the report so far. Meanwhile, the top 30 publicly traded US-based exploration and production companies collectively booked $101 billion in asset impairments last year.


Oil-patch-bankruptcies-soar Oil-patch-bankruptcies-soar44 Oil-patch-bankruptcies-soar3Adapt or die 

As weak producers collapse, oil industry leaders are becoming more and more efficient at what they do. Operators have been adding horizontal rigs in the most efficient tight oil plays this year as cost reductions make production profitable even at today’s low prices.

Between July 1 and August 12 drillers have added 66 oil rigs, the longest streak of rig additions since April 2014, when WTI was trading at and above $100 a barrel. According to Wood Mackenzie around 68% of the rig additions since June predominantly located in the Permian Basin (60%), which possesses the greatest depth of resource economics at $60/bbl and below. Efficiency gains will only make these wells more economically valuable. A report from Deutsche Bank’s integrated oil analysts Ryan Todd and Igor Grinman last week claimed that US oil producers will see further efficiency gains of 21% next year as capital goes further on a per well basis than it has done for many years.

It’s fair to say that on the whole, the North American oil industry is in disarray and as oil producers are fighting each other for survival they’re neglecting oil assets throughout the country. The competition is intensified by new legislation. The SEC Jobs Act Title 3 that went into effect in May is creating new opportunities to increase innovation in the space. For the first time in 80 years, most Americans can invest directly in oil wells.  One company leading this trend expanding the pool of investors in early stage oil wells is Crudefunders, a crowdfunding platform based in Dallas.

Crowdfunding oil wells is not as crazy as it might sound. Since the oil downturn began, North American banks have become skeptical about lending to the sector, and as bankruptcies have mounted, banks have only become more cautious. Deploying the power of the crowd bypasses banks and helps lower the cost of capital for projects, ultimately reducing their breakeven cost.

Does crowdfunding make sense for the average investor? 

Previously the only way for investors to get in on the North American oil renascence was to buy stock in a public oil company or buy an oil well. However, most investors don’t have the capital and expertise to buy a physical oil well and when you invest in a publicly traded company you’re investing in not only in gas assets and production capabilities but you’re also buying their debt, employees and marketing budget.

By investing directly in the oil prospect via CrudeFunders investor there’s no need to play the market or operate the well yourself. What’s more, there’s a huge tax benefit on offer for investors. Intangible Drilling Costs (IDCs) represent all expenses an operator may incur at the wellsite that – by themselves – produce a physical asset for the producer. To encourage onshore drilling, US tax authorities allow these costs to be written off (and have allowed this in one form or another since 1913) against income, up to a value of 80% in the first year against active income.

Clearly, there are enormous benefits for investors using this platform but what about transparency? There are plenty of horror stories about investors being drawn into oil & gas scams over the years. Allan Fine, co-founder of CrudeFunders, wants to change that. According to Mr. Fine, “we charge a 10% success rate…we disclose what our compensation is, how much it is to build the well, and so we think we are a really good alternative for the investor because when they get the product, it’s not so marked up they don’t have a chance of making money.” CrudeFunder’s bypasses Promoters who have a history of “hard-sell, boiler-room style tactics”. (  “We’re really displacing the whole Wolf of Wall Street Mentality,” Fine added.

Mr. Fine is not promising sky-high returns or sugar coating profits for investors, “Drilling for gas is a risky business and we try to de-risk it as much for investors but things happen.” He goes on to state that assets are only allowed on the portal if they meet strict criteria for returns based on a discount cash flow analysis using the “NYMEX strip price over a 5-year period.”


crowdfunding Screenshot via CrudeFinders
Screenshot via CrudeFinders

Too good to be true? 

This all may seem too good to be true but in today’s world where almost every industry is suffering from disruption in one form or another, crowdfunding oil wells could be the next big thing. Certainly, for private investors, the tax benefits make a lot of sense.

Nonetheless, this isn’t the first time someone has tried to democratize the oil sector by offering a share of production to private investors most previous attempts have been scams. In fact, scams are so prevalent that the SEC has devoted part of its site to the Common Red Flags that generally indicate a scam. It’s worth checking out before trying to invest with any of your cash. Allan Fine is hosting a talk to discuss concerns like these and opportunities presented by new crowdfunding

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