Market Watch : Crisis Spurs New Interest in Risky Oil and Gas Deals

The crisis in the Middle East is driving up commodity prices and spurring a wave of speculation in such previously moribund investments as oil and gas limited partnerships.

Investments in partnerships that promise to drill new wells are particularly strong, said Furman Nettles, vice president of Robert A. Stanger & Co., a Shrewsbury, N.J., consulting firm. Only last year, oil and gas partnership sales hit a 12-year low.

The theory behind the boom is that rising energy prices are increasing the value of oil discoveries, which in turn improves potential gains from drilling investments. Still, experts say the partnerships might not be bargains because of high risks, big up-front fees and hidden costs.

Moreover, they say, it takes so long to turn investor money into a producing well or oil field that the recent price swing means little.

“It is going to take something longer-term than the Iraq situation” to improve fortunes for oil and gas investors, said John Owens, a partner at the accounting firm of KPMG Peat Marwick in Los Angeles.

Although crude oil shot up to the upper $20s per barrel after Iraq invaded Kuwait on Aug. 2, no one is predicting $100-a-barrel oil as they were in the mid-1970s and early 1980s, when many energy partnerships were launched. Instead, industry experts believe oil prices will slide sharply as soon as there is some resolution to the Persian Gulf situation, before bouncing back modestly.

“We think prices are going to average $21 or $22 (a barrel) this year and increase by about $1 next year,” said Timothy Curro, vice president of research at First Boston Corp. in New York. In 1992 and beyond, Curro expects about a 7% annual rate of increase in oil prices.

Natural gas prices are another story, industry experts said.

The natural gas market is depressed by a “bubble” of oversupply. Normally, the cost of 1,000 cubic feet of natural gas should be one-sixth the price of a barrel of oil, said Nettles. In other words, when oil was selling at $18 a barrel, 1,000 cubic feet of natural gas should have been about $3.

Now that oil is selling in the high $20s, natural gas should be selling around $4, Nettles said. But with the oversupply, natural gas is selling for $1.50 to $2.10.

Nettles expects the natural gas glut to ease even if the Mideast crisis is quickly resolved, making investments in these partnerships more attractive.

However, investing in any type of limited partnership is risky.

First, many partnerships are privately traded. That means investors might have a hard time selling. Moreover, without a public market, it is difficult to determine their true value without a costly audit.

In addition, these partnerships typically charge upfront fees ranging from 9% to 15% of the original investment. Some partnerships have additional hidden costs, Nettles said.

For example, an oil drilling partnership may promise to give investors 99% of revenues produced by a well until they get back 100% of their original investment. Sounds good? What investors may not realize is that their 99% comes after the partnership pays its expenses, which just might include a 12.5% fee to the land owner; a 6.5% fee to the “land man” who helped find the property, and another large chunk to a driller.

In some notorious cases, the contractors have had ties to the partnership’s promoter. Not surprisingly, the promoter made a fortune while investors earned virtually nothing.

Consumers also need to be wary of con artists who exploit market fears to sell bogus partnerships. Already, state regulators said, there has been an upswing in commodities scams, including some oil and gas deals.

Even in the best cases, limited partnerships often do not produce high enough returns to compensate for the risks, Nettles said. Robert A. Stanger & Co. studied returns on oil and gas partnerships and found that investors got back $1.40 for every $1 they put in over a 10-year period. That’s a lower return than on Treasury bills.

If investors are lucky enough to find a well-run partnership that comes across a big find, they can make hefty returns. There can be tax benefits, too.

Still, experts say that no one should invest based on a potentially short-term event such as the Persian Gulf crisis. Not only could the crisis end quickly, other countries could boost oil production and create a price-depressing glut.

Nettles’ firm has a 900 number that provides information on, among other things, partnerships’ past returns and the value of their reserves. The service, which costs $5 a minute, can be reached at 900-786-9600.