Energy Investments: A Huge Risk for Investors, Especially in Private Placements
Energy investments might involve the development of oil and gas reserves, exploration of reserves, drilling for oil, or refining. Energy investors can also invest in companies that rely on coal or renewable energy. These investments are extremely volatile and speculative. After all, some energy companies literally “dig for oil,” an inherently uncertain process. Volatility means that an investment is likely to experience extreme price fluctuations — in this case, due to changes in supply and demand. Oil drilling and well exploration are costly endeavors, and companies turn to deep-pocketed investors to fund their production costs. Investors in the oil and gas sector should be ready to bear significant risk.
Types of Energy Investments
Energy investments can take many forms.
Commodity-based ETFs with underlying energy investments are among the most common investments in the energy market. Because these investments are pooled, it is possible to invest in several different energy companies through a single ETF.
Investors who can bear significant risk may also consider an energy futures contract. Futures allow investors to speculate about the future price of oil and coal.
Private placements in the energy sector are usually only available to accredited investors with a high net worth. Private placements are especially risky because these investments are not subject to the same disclosure rules as public companies. Private placements are also illiquid because investors cannot buy and sell their shares on a stock market, and there is no secondary market for these types of securities.
Energy Investments 101
If your broker solicited you to invest in a private placement in an energy company, check with the SEC to ensure the investment is a legitimate offering. Look for offerings on the SEC’s Edgar Database. Exempt private placements may not have to register their offering with the SEC but still must file a Form D.
Only purchase energy investments through registered brokers and/or registered investment advisers. Look up brokers on FINRA’s BrokerCheck and SEC advisers through the Investment Adviser Public Disclosure (IAPD).
If investors buy shares of a private oil or energy offering, they should be especially thorough when researching the investment. The SEC states in a Private Oil and Gas Offerings Investor Alert that investors should always know all the facts regarding:
- Large sales fees paid to brokers and promoters.
- The nature and size of compensation to the promoter.
- Operating and other expenses for unrelated businesses.
- Whether the promoter plans to use money raised from investors to pay for personal items.
Brokers and brokerage firms have a duty to perform their due diligence before they recommend a private placement to investors. Investors can request that their broker supply them with the due diligence report for a given energy investment.
The SEC also recommends that investors review the following:
Well History—Is there a prior history of drilling at the specified well? Why does the private placement company believe they can extract any more oil? Geologists may evaluate terrain to detect the signs of an oil reserve. For instance, the presence of certain microfossils indicates the conditions were ripe to form an oil deposit. Investors should find out if the oil company has performed these evaluations and review the results for themselves.
Reserves—Who determined the reserve estimates? Were they audited or reviewed by an independent third party? Keep in mind that reserves can be “proved,” “probable,” or “possible.” The mention of reserves alone should not assure investors that plenty of oil is available.
Oil reserves could face significant problems in the next few years. Many reserves have not met expectations for their outputs, and discoveries of new reserves have not increased quickly enough to replace depleted reserves.
Issuer History—Find out if the issuer has had previous success with their oil wells.
Red Flags: Oil Investment Promoters
Remember, oil investment promoters and brokers can make a lot of money from their promotions. Because of this, the SEC recommends that brokers watch for the following:
- Abnormally high rates of return.
- “Guaranteed” returns. Oil investments should never offer such guarantees.
- “Once-in-a-lifetime” sales pitches.
- Requests to sign documents stating that securities laws do not apply to an investment.
What Causes Volatility in the Energy Market?
The machine that brings oil to the market has many moving parts. Those moving parts include the Organization of Petroleum Exporting Countries (OPEC), natural disasters, civil unrest in oil-producing companies, and oil demand—demand that is easily affected by the weather and the economy. The market has begun to favor green energy investments, but despite their increasing popularity, the post-pandemic price of oil indicates that our dependency on crude oil is far from over.
Prices drop when demand drops. The 2020 quarantines and stay-at-home orders decreased demand and caused a sharp drop in oil prices. When the pandemic shutdown orders started to lessen, a considerable wave of travelers embarked on long-delayed trips, resulting in a massive spike in demand for oil.
OPEC controls how much oil comes out of the Middle East, and their refusal to ramp up or slow down oil production has a major impact on prices. For instance, oil prices surged through October 2021, leading the U.S. to pressure OPEC to increase their production caps. So far, they have only agreed to modest increases. Industry analysts have speculated that the pandemic is still a concern for OPEC, who likely do not want to increase oil production only to see demand swiftly drop off in the coming months.
Hurricanes in the Gulf can destroy offshore drilling platforms and cause substantial oil spills to the detriment of shareholders. 2021’s Hurricane Ida resulted in spills that led to a massive shutdown for U.S. oil companies.
Examples of Energy Investment Disputes
Brokers and registered investment advisers have an obligation to perform their due diligence before recommending an energy investment to a client. They also have an obligation to disclose any personal stake in an oil and gas company. In a recent investor dispute, an investor alleged that a broker had failed to reveal their connections to an energy company’s CEO. The investor sought to recover over $180,000 from their brokerage firm.
Investors claimed over $5 million in losses when a broker recommended investments in Foresight Energy LP. Foresight Energy is a coal mining company. Coal has declined in popularity in recent years as companies switch to less-polluting sources of energy. Foresight Energy stopped distributing dividends to investors in May 2019 and then filed for bankruptcy in 2020.
Certain brokers have allegedly over-concentrated their investors in the volatile energy sector. Brokers should know that this tactic will likely lead to losses and should balance any risky energy investments with more reliable stocks and bonds.
What Can I Do If I Lost Money on Energy Investments?
Investors who were not aware of the risks of their energy investment should speak to a securities attorney. Kurta Law will evaluate your case for free.