What are Non-Traded Oil and Gas Limited Partnerships?
One particularly troubling type of private investment is a security known as a non-traded Oil and Gas Limited Partnership. These securities are investment pools designed to fund energy projects—specifically oil and gas wells.
These securities are not registered with the Securities and Exchange Commission, which makes them private placements. Like all private placements, these securities are not sold on public securities exchanges, but they are instead offered directly to investors by the promoting brokers. These investments are not to be confused with Oil and Gas MLPs or Master Limited Partnerships that do, in fact, trade publicly.
Unlike other start-ups that plan for a long-term future, these securities are only formed to fund one singular project and then are liquidated upon the project’s completion. Most individuals who invest in this product are considered limited partners. Although they are still part-owners, these investors have no actual decision-making power because that is left to the general partner or partners. The general partner is the one tasked with managing the project.
Oil and Gas Limited Partnership Projects
There are a few different types of projects that oil and gas limited partnerships can embark on. These projects range in risk and are often the determining factor regarding how successful the investment is. The project could be pumping petroleum and gas from an existing well; drilling for oil and gas in a proven oil field; or searching for new oil and gas fields. Obviously, the greater the risk of obtaining these energy sources, the greater the reward is for actually obtaining them. However, the general partner(s) has full discretion regarding the level of risk that the project embarks on.
Just like for all private placements, those managing oil and gas limited partnerships are not required to provide investors with a prospectus. This is a financial document detailing the company’s business plan and showing how invested funds are going to be used. Due to this lack of prospectus, limited partners may not be made aware of the level of risk the partnership is undertaking prior to them becoming partners.
There is very little that can stop general partners from placing their own financial interests ahead of the limited partners’. This includes embarking on an incredibly risky project that can prove financially detrimental to the limited partners.
The level of risk proves to be irrelevant for most investors regardless. This is because even if the partnership chooses the safest route possible, it is still far riskier than regular publicly-traded securities. The main reason for this is due to how unstable the energy market actually is. Oil and gas prices fluctuate so quickly, and a decline in value can greatly diminish the demand for these energy sources.
Oil and Gas Limited Partnerships Are Incredibly Illiquid
Like all private placements, oil and gas limited partnerships are incredibly illiquid investments. Privately traded securities, such as these, lack the guaranteed redemptions that accompany securities sold on public exchanges. In other words, an investor can redeem their shares of a publicly traded security at any moment for the amount the shares are presently valued at.
However, this is not the case with an oil and gas limited partnership. Since these partnerships are designed to fund singular projects—as opposed to maintaining capital for continued operations—the general partners often wish to deter any liquidation until the project is completed. Because of this, investors cannot simply redeem their units for what they are told the shares are currently valued. It is unfortunately more complicated than that.
Investors looking to withdraw from these investments before the project’s completion are offered scheduled buy outs usually on a quarterly basis. However, not every investor looking to withdraw is offered a buy out as there are only a finite amount offered each period. In addition to this, investors are not offered a buy out price that is equal to what they are told the shares are currently valued at.
Sometimes, investors are offered buy outs from third party companies; however, the prices are often even less than what the limited partnership offers at its quarterly buy outs. Rather, investors are pressured into staying until the project’s completion if they wish to receive the full amount they are told their shares are worth. This can be detrimental to investors depending on how the investment is doing. If the project is doing poorly, and very little oil and gas is being obtained, investors can be literally trapped in a failing investment with no means of escape.
Brokers Take Advantage Of Investors By Recommending Unsuitable Oil and Gas Limited Partnerships
Oil and gas limited partnerships are also accompanied by a great deal of upfront fees charged to the investor. While these fees include a great deal of highly unnecessary expenses, most of them are paid to the recommending broker as their commission for brokering the trade. A broker’s commission for these products can sometimes even come out to a whopping 10 percent of the investor’s principal investment.
This commission is compounded with other upfront fees that can almost lower an investor’s principal by 17% right off the bat. When an investor’s principal investment is lowered that significantly, seeing any returns on their investment becomes incredibly difficult.
This fact, along with the incredible risks and illiquidity associated with oil and gas limited partnerships, is often omitted by recommending brokers trying to obtain the incredibly high commission. Many brokers pitch these investments with a promise that the general partner(s) has stumbled upon something great. They might also bring up that significant dividends outweigh any threat of risk; however, they often leave out the fact that these dividends are entirely dependent upon the partnership’s success and that they can be yanked away from the limited partners at any moment if the value of the partnership begins to fall.