Oil and Gas: Volatile Investment : Though Boiler-Room Scandals Have Tarnished This Legitimate Roulette Wheel, There Are Some in the Drilling Game Who Know How to Play With Fire

Lately, when talk turns to Newport Beach oil and gas operators, people tend to conjure up images of slick telephone salesmen making wild promises to naive grandmothers in small Midwestern towns.

But despite Orange County’s reputation as a center for boiler-room scams, not all oil and gas investors get taken for a ride.

Bill Williams, for example, receives about $2,500 a month from oil and gas investments. The 76-year-old retired engineer lives comfortably on his sailboat in Huntington Harbour. He also has a home on 5 acres in Elsinore but prefers the harbor to the hills.

Williams is one of of about 15 Southern Californians who invest in BCS Natural Resources of Newport Beach, a private firm that channels $2 to $3 million a year into oil and gas drilling projects.

“There are good guys and there are bad guys,” acknowledged Williams, who said he once lost $40,000 in a single oil investment.

Williams has invested $250,000 with BCS since 1979, and he is pleased with the results. So far, he has recovered nearly half of his $250,000, and he expects to double or triple his original investment over the long term.

“We’ve had some dry holes, but you cannot go into oil one year at a time,” he said. “You have to be prepared to stay in for at least five years and average the good years against the lean years.”

BCS is something of a dinosaur among Orange County’s investment firms, a survivor of the oil-boom days with a small but loyal following.

It has few rivals here, partly because oil and gas drilling ventures are not very popular these days. Since their heyday in the early 1980s, drilling funds have fallen from favor as a result of declining oil and gas prices, tax law changes and poor returns received by many investors.

“I think every doctor and lawyer in Orange County must have lost $50,000 in oil and gas funds at some point in the 1980s,” said Jeffrey Kilpatrick, president of Newport Securities, an Orange County brokerage. “I don’t know of a single client who has invested in a fund that has ever made a true profit.”

Added Michael Cummins, a broker specializing in energy stocks with Drexel Burnham Lambert in Newport Beach: “You don’t even broach the topic with clients. It’s something you just don’t want to bring up.”

Recent raids on oil and gas investment scams by securities regulators have further tarnished the image of legitimate operators. Last month, securities regulators from five states raided three Southern California telephone solicitation firms accused of peddling at least $8 million in illegal oil and gas investment programs.

In Kilpatrick’s view, oil and gas investments are definitely not for the average guy.

“Oil and gas is an aficionado investment,” he said. “It’s for the investor who is looking for obscure, oddball investments. It’s for the guy who likes to drive a Ferrari and keep a lion for a pet. That’s not the right kind of car or pet for a normal guy. And oil is not the right kind of investment. It’s only for guys who have a lot of money to play the game.”

Across the country, investments in oil and gas drilling funds have fallen dramatically since the height of the oil boom in 1981, although they appear to be mounting a modest comeback.

According to Robert A. Stanger & Co., a New Jersey research firm, total investments in publicly registered funds that solicit from investors to drill oil and gas wells have plunged from a peak of $2.1 billion in 1981 to only $111 million last year.

Investments in private drilling partnerships such as BCS have experienced a similar descent, falling from $1.9 billion in 1981 to an estimated $50 million in 1987.

Another kind of oil and gas investment, the income fund, has partially offset the decline of the drilling funds. Income funds buy existing wells with proven production, thus avoiding the embarrassment of dry holes but forgoing the allure of a possible big strike.

Stanger’s statistics show that investments in publicly registered income funds fell from a record $2.1 billion in 1983 to only $254 million in 1985, but they recovered to nearly $1 billion last year.

According to authorities, successful oil investors tend to invest in private funds with managers they know and trust.

BCS Resources, for example, relies on a small group of regular investors for the bulk of its capital. Its president, Loyd Sellinger, said he never solicits investments, although new participants come to him from time to time by word of mouth.

“Very few people know about me,” Sellinger said. And he likes it that way.

BCS was co-founded in 1970 by Sellinger, who bought out three partners over the years. The money he raises each year is invested in joint-venture drilling deals with major oil companies such as Sohio and independent oil firms such as Sabine. Last year, Sellinger’s firm invested in 23 drilling projects. Most were natural-gas wells.

Edward Schumacher, former chief executive of Global Van Lines, is another long-term investor in BCS. When Schumacher and three partners sold Global in 1981, he began investing 25% to 30% of his assets in BCS. Like Williams, he has recovered about 50% of his total investment so far, and he ultimately expects to make a profit.

“What you have to remember is that a lot of your money is still in the ground,” he said.

In addition to the cash return, oil and gas ventures traditionally have been a favorite tax shelter for wealthy investors. Typically, much of the money invested in a drilling deal can be deducted during the same year in the form of intangible drilling costs. Investors also receive continuing tax deductions from depreciation and depletion.

Although the tax benefits of oil and gas investments were diminished somewhat by the tax reform act of 1986, drilling deals are still good shelters. The top personal income tax rate was lowered from 54% to 33% by the new tax law, but the government still allows investors to deduct 100% of intangible drilling costs.

Schumacher said that any tax benefits he has received over the years have been “frosting on the cake.” His primary objective has been to make a profit.

“When I show my returns to accountants, they shake their heads and say that they don’t usually see these kinds of positive numbers,” Schumacher said. “I’d be very leery of continuing without this kind of track record. There are a lot of oil and gas investments where it’s just money down a rat hole.”

James Hamilton, an attorney with Paul, Hastings, Janofsky & Walker in Costa Mesa, has invested in BCS since 1978. “I don’t pretend to understand the oil and gas business. In these sorts of investments, you are really at the mercy of the fund managers. When I first invested at BCS, I wasn’t sure how it was going to turn out. But at least I knew Sellinger personally and I knew he had a personal stake in seeing that his investors come out OK.”

Hamilton said his experience with public drilling funds was far less rewarding.

“When you are just a faceless name in a (public fund) offering, they don’t take the same interest,” he said. “I’ve been invested in a few public deals where I never heard back from the managers.”

Thomas R. Hunt, a spokesman for the California Independent Petroleum Assn., said Sellinger is a legitimate oil and gas operator with a good track record.

BCS invests primarily in relatively expensive, deep gas wells drilled to depths of 18,000 feet or more. The wells typically cost $1.5 million to $2 million to drill and complete.

But Sellinger said he never invests more than $100,000 or assumes more than 25% of the drilling costs of a single well. Such diversification helps to protect investors, because many wells turn out to be dry holes.

Sellinger, who spends most of the year in Texas and Oklahoma picking out his deals, said depressed natural gas prices have him eager to go bargain hunting.

“Right now is one of the best times since 1969 to invest in natural gas,” he said. “You have to be a bit of a contrarian. Drilling prices are so low that they’re back to 1976 levels. One thing I know is that people make their big money in bad times, not good times. And we are going to be in bad times for another two or three years.”

Sellinger expects average natural gas prices to rise from a current level of about $1.50 per thousand cubic feet to more than $2 by 1991. Based on traditional price relationships, natural gas is selling “at an unbelievable discount” to crude oil, he said.

Of the 23 wells in which BCS participated last year, 10 are producing natural gas, one is a producing oil well and the rest were dry holes. “For our type of drilling . . . 1987 was a very good year,” Sellinger said.

Sellinger said he personally invests about $50,000 a year in the drilling ventures sponsored by BCS. In addition to his proportionate share of production revenue, Sellinger receives an additional 7% of the income generated by the wells until his participants recoup their initial investments. After his investors break even, he increases his take to 15%.

Sellinger said he makes sure that participants understand the risks before he lets them place bets on his roulette wheel. A prospective investor must be accompanied during initial discussion by an attorney, an accountant or a certified financial planner.

“We sit down and explain that the potential investor should expect to stay invested for three to five years. We also explain that we can’t always have a good year for discovery,” he said.

“We stress the risk. We stress the fact that you could lose 100% of your money. It’s never happened to us, but it is possible.”