Did you invest in some sort of Energy Investment with the hopes of making a nice return on your investment only to suffer huge financial losses because of the falling price of oil and gas? Many investors think that they are a victim of the economy and falling oil prices, but our office, through its investigation has found that many of these types of investments had little hope of providing a decent return (ROI, ROE) even if the economy and the energy prices had not tanked. This is just one in a series of articles in Oil and Gas investments as products, and what to look out for. To obtain a full understanding of the pitfalls of this area, please read all four blogs, or call us to discuss this complicated area.
There are numerous ways to invest. Our office has seen the most problems with the Master Limited Partnerships, (MLP), and Direct Participation Programs, (DPP). These are private placement offerings, meaning that they are not offered to the general public unless investors go through a broker or a financial planner. These are marketed as elite and exclusive products but in reality they perform worse than the publicly available products. They are higher leveraged and thus higher risk. Within each of the MLP and the DPP, the energy sector is further divided into many sub-markets. The sub markets include: Explorations and Production, Transportation and Storage, Refining and Marketing and the Energy Service sector. There are MLP and DPP in many of these submarkets also.
The fees for the General Partner often are excessive and not properly disclosed. The MLP investors, unlike the stockholders in C- Corporations, have limited control and voting rights. There are significant conflicts of interest between the sponsor, the General Partner and the Limited Partner. Most often our office sees General Partners taking advantage of the Limited Partners.
Compared to the publicly traded counterparts, the MLP are more susceptible to market changes and studies have shown that they decline precipitously more than the publicly traded C- Corps during market decline. Broker’s often present these products as having reduced volatility, but the opposite is true according to various research studies.
An expert compared the private placement Alerian MLP with the publicly available (AMLP) ETF and found that there was a lower return, a distortion of the tax benefits in the private placement MLP. The cumulative returns of a typical MLP lagged the publicly available ETF (Exchange Traded Fund) index by 15% and sometimes the returns were even 50% lower than the publicly traded alternative.
You may own a Direct Participation Program and not even know it. Brokers often convince investors that these Oil and Gas investment programs or DPP’s are the answer to your tax problems. While it is true that DPPs have some tax write offs associated with their programs, not every investor taxpayer benefits from the specific tax benefits provided. Also, no amount of tax write off can ever make up for the complete loss of an investment in these programs. Investors may save on taxes for a year or two, but they end up losing all their investment with nothing to show for it except a year of some tax savings.
There are high upfront fees and high management fees. An expert compared the expense ratio of the (private placement) Ridgewood Energy Funds with the Vanguard Energy Fund and the fees were more than nine times higher in the Ridgewood Energy Funds. Also, in addition there was ongoing Management Fees in the Ridgewood Energy Fund had eroded over 21% of the total revenue to the investors.
Many of these investments have high fees, high risks and are illiquid, meaning that you can’t sell them and you are stuck once you bought into them.
As of May 31, 2016, there were 315 Exploration and Production companies and 97 Equipment and Service companies. Some examples of DPP’s are: Cataylst Energy, Noble Royalties, Ridgewood Energy Funds, Petrol Energy, Atlas, NGAS, Magnum Hunter, ICON, ATEL and hundreds of other sponsors.