Before investing in any oil and gas program, you need to verify claims, understand structures, and assess risks. This checklist covers what sophisticated investors examine before committing capital.
The Due Diligence Framework
Thorough due diligence examines four areas:
| Area | Key Questions | Red Flag Threshold |
|---|---|---|
| Sponsor | Track record, expertise, alignment | No verifiable history |
| Operator | Drilling success, basin experience | Below-average completion rates |
| Deal Structure | Fees, working interest, projections | Fees >20% of capital |
| Legal/Regulatory | SEC compliance, offering documents | Missing or incomplete filings |
Sponsor Evaluation
The sponsor (or syndicator) is who packages the investment and raises capital. They’re your primary counterparty.
Track Record Verification
What to verify:
- How many wells/programs have they completed?
- What is their actual investor return history?
- Can they provide audited results (not just projections)?
- How long have they been operating?
How to verify:
- Request investor references (and actually call them)
- Check SEC EDGAR for past Form D filings
- Search for litigation (FINRA BrokerCheck, state court records)
- Verify professional credentials claimed
Red flags:
- Fewer than 5 years in business
- Fewer than 10 completed wells
- No references available
- History of regulatory actions or investor complaints
Expertise Assessment
Questions to ask:
- Who on your team has petroleum engineering credentials?
- Who evaluates the geology before you invest?
- What is your well selection process?
- How do you choose operators to work with?
What good looks like:
- Registered petroleum engineer on staff or retained
- Geologist reviewing reserve estimates
- Documented operator selection criteria
- Technical advisory board
What bad looks like:
- Pure financial/sales background
- Reliance on operator’s representations alone
- “We trust our partners” without verification
- No technical due diligence process
Alignment Check
Key questions:
- Do principals co-invest in every deal?
- What percentage of compensation comes from carried interest vs. upfront fees?
- What happens to your money if the sponsor fails?
Ideal structure:
- Principals invest alongside LPs (minimum 5% co-invest)
- Majority of compensation from carried interest
- Clear provisions for sponsor removal/replacement
Operator Evaluation
The operator is who actually drills and produces the wells. Even a great sponsor can’t save you from a bad operator.
Performance Metrics
| Metric | Good | Average | Concerning |
|---|---|---|---|
| Well success rate | >90% | 80-90% | <80% |
| Production vs. type curve | >100% | 90-100% | <90% |
| LOE per BOE | Basin competitive | +10-20% | >+20% |
| Time to first production | On schedule | +10-20% | >+30% |
Basin Experience
Critical: Operators should have significant experience in the specific basin where your wells will be drilled.
What to verify:
- How many wells has this operator completed in this basin?
- What is their average IP (initial production) rate?
- How do their wells compare to basin averages?
- Do they own acreage or are they purely contract operators?
Financial Stability
Why it matters: An operator in financial distress may cut corners on completions, delay workovers, or go bankrupt mid-program.
What to check:
- Credit facility status (if public, in 10-K filings)
- Hedging program (protection against price drops)
- Debt-to-EBITDA ratio (below 2.5x is healthy)
- Negative news coverage or analyst concerns
Deal Structure Analysis
Fee Comparison Framework
| Fee Type | Reasonable | High | Excessive |
|---|---|---|---|
| Placement fee | 1-2% | 3-4% | >5% |
| Organization fee | 0-1% | 1-2% | >2% |
| Management fee | 1-1.5% | 1.5-2% | >2% |
| Carried interest | 15-20% | 20-25% | >25% |
| Total load | 15-20% | 20-25% | >25% |
Projection Scrutiny
Test the assumptions:
- Price assumptions: What oil/gas price is used? Is it current strip or optimistic?
- Decline curves: Are they using actual analog wells or theoretical curves?
- Operating costs: Are LOE assumptions realistic for this basin?
- Downside scenarios: Is there sensitivity analysis at $50, $60, $70 oil?
Request:
- Type curve source data (actual nearby wells, not hypotheticals)
- AFE (Authorization for Expenditure) breakdown
- Multiple price scenario projections
- Historical accuracy of past projections vs. actuals
Working Interest Structure
Understand exactly what you’re buying:
| Term | Definition | What to Verify |
|---|---|---|
| Working Interest (WI) | Your share of costs and revenues | Percentage ownership |
| Net Revenue Interest (NRI) | Your share after royalties | WI × (1 - royalty burden) |
| Royalty burden | Mineral owner’s share | Typically 12.5-25% |
| Reversionary interest | Sponsor’s additional share after payout | When it kicks in, percentage |
Example calculation:
If you own 5% Working Interest
And royalty burden is 20%
Your NRI = 5% × 80% = 4% of gross revenueLegal and Regulatory Checklist
SEC Compliance
For Reg D offerings, verify:
- Form D filed with SEC (search EDGAR)
- Filing within 15 days of first sale
- Proper exemption claimed (506(b) or 506(c))
- Accreditation verification (506(c) requires actual verification)
State Registrations
Blue sky compliance:
- Notice filings in your state
- Sponsor registered in operating states
- No stop orders or enforcement actions
Document Review
Key documents to read completely:
-
Private Placement Memorandum (PPM)
- Risk factors section (they’re required to disclose risks)
- Use of proceeds (where your money actually goes)
- Conflicts of interest (sponsor self-dealing)
-
Operating Agreement
- Cost allocation methodology
- Operator removal provisions
- Cash call procedures
-
Subscription Agreement
- Representations you’re making
- Dispute resolution (arbitration vs. courts)
- Transfer restrictions
Reference Check Script
When calling investor references, ask:
- How long have you invested with this sponsor?
- How have your actual returns compared to projections?
- How is their communication and reporting?
- Have you experienced any unexpected capital calls or fee increases?
- Would you invest with them again? Why or why not?
- What’s one thing you wish you’d known before investing?
Listen for:
- Hesitation or qualified answers
- Discrepancies with sponsor’s claims
- Complaints about communication or transparency
- Unexpected negative surprises
Background Check Resources
Free Resources
| Resource | What It Shows |
|---|---|
| SEC EDGAR | Form D filings, any SEC actions |
| FINRA BrokerCheck | Broker registration, complaints, disciplinary actions |
| State securities regulators | Registration status, enforcement actions |
| Court records | Litigation history |
| Better Business Bureau | Consumer complaints |
Professional Due Diligence
For investments above $250,000, consider:
- Independent petroleum engineering reserve report ($5,000-$15,000)
- Legal review of offering documents ($2,000-$5,000)
- Background check on principals ($500-$2,000)
- CPA review of tax implications ($1,000-$3,000)
The cost of professional due diligence is small relative to protecting a significant investment.
The Final Checklist
Before investing, confirm:
Sponsor
- Verified track record with actual investor references
- Petroleum engineering expertise on team
- Principal co-investment in every deal
- No litigation or regulatory issues found
Operator
- Proven basin-specific experience
- Production performance at or above type curve
- Financially stable (not distressed)
- Good reputation with industry peers
Deal
- Total fees below 20% of invested capital
- Projections based on realistic assumptions
- Downside scenarios show acceptable risk
- Clear understanding of working interest structure
Legal
- SEC Form D properly filed
- State notices in compliance
- PPM read completely, risks understood
- Operating agreement terms acceptable
Personal
- Investment appropriate for my risk tolerance
- Illiquidity acceptable for my time horizon
- Tax benefits applicable to my situation
- Diversification across multiple wells/programs
The Bottom Line
Due diligence takes time—expect to spend 10-20 hours evaluating any significant investment. The sponsors who make this process easy (providing references, sharing data, answering questions thoroughly) are usually the ones worth investing with.
The sponsors who get evasive, rush you to decide, or can’t provide documentation are telling you something important. Listen.
This checklist is for educational purposes. Adapt it to your specific situation and consult professional advisors for significant investments.