Risk Management
What are the Financial Risks?
Oil and gas drilling projects have two initial phases of investment:
Dry Hole Costs (DHC) - All costs up to and including drilling the well and testing for the presence of hydrocarbons. In addition to drilling expenditures, these include the costs for leasing land, seismic purchase and reprocessing.
Completion Costs - All costs associated with "fracking" a positively tested well and putting it on production.
The primary risk to an investor's capital is drilling a well and not finding oil or gas. Dry hole costs are usually 2/3 or more of the total capital at risk in drilling a well. Once a well tests positive for hydrocarbons, the operational risk level is usually reduced.
Dry hole risk can be effectively managed in two ways: choose your operating partners well and employ drilling capital in a disciplined, diversified manner.
How Does Gulf Coast Midwest Employ Capital?
Diversification is a familiar term in business and to most investors. The phrase: "Don't put all of your eggs in one basket." applies whether you are trying to decide what stocks to purchase or how to allocate your assets between industries. While the old saying certainly captures the essence of the issue, it provides no practical guidance on the role diversification plays in managing risk.
Concentration Risk - Managing the Down Side
Dry holes are inevitable when drilling for oil and gas. The key for prudent investors is making sure dry holes can't hurt the overall return on capital invested in oil and gas wells.
Avoiding investment concentration is the single most important strategy to mitigate operational risk for investors participating directly in oil & gas projects.
An average U.S. Gulf Coast developmental well would have a 60% chance of success and a cost profile that looks something like the diagram to the right.
An investor who has allocated $500,000 to direct oil and gas projects is given two choices:
- Invest $500,000 for 20% of 1 well.
- Invest $12,500 per well in 40 wells.
While in both cases, the investor has a 60% chance of economic success, all investors given this choice will choose to manage their downside and invest less money in more wells.
Gulf Coast's investment style is designed specifically to avoid wellbore concentration risk by capping what is invested in dry hole cost for a single well at 2.5% of total capital. We add further diversification by partnering with up to 10 top-tier operators per program!
Building a 40 Well Program
Gulf Coast Midwest takes a pyramid approach to building its portfolio of wells. We ascribe to the notion that making an above-average return frequently is better than a tiny chance at winning the lottery.
The pyramid can be thought of as an allocation tool that builds on lower risk wells at the base that can give us a reasonable return. At the summit, we are participating in higher risk / high return wells that, if successful, can take our returns to an entirely new level. If the high risk wells are not successful, our overall concentration is low enough that we will not materially damage our portfolio return.
The pyramid, representing our portfolio of wells, has three distinct tiers:
Base of the Pyramid - Our foundation for drilling is in resource plays. Gulf Coast Midwest is active in the Wolfberry play in the Permian Basin with multiple operating partners.
We have other operating partners who specialize in acquisitions of undervalued production.
Gulf Coast Midwest looks to invest 50% to 65% on this level of the pyramid, which supports everything above it. The risk profile of these wells is low with good returns.
Middle Portion - This level is made up of medium-risk developmental wells that can be characterized as shallower (
Summit - This class of wells will make up 5% to 10% of Gulf Coast Midwest's well portfolio. The wells are deeper and usually pressured. The potential reserves sought are in the 20Bcf to 50Bcf or higher range; many degrees of magnitude higher than the shallower wells. Our operating partners in this class have decades of experience in these areas of operations. This is enormously important given the higher geological risk and the additional operating complexities associated with these deeper wells.
The Win-Win
Gulf Coast Midwest's pooling approach to investing in oil and gas projects allows all sides to benefit:
Gulf Coast Midwest Investor Partners
Instant Diversification - Gulf Coasts investors are provided with the immediate benefit of instant diversification and asset allocation without the large amounts of cash needed to create an individual portfolio of wells.
Consider an operator of the well described above who needs $2.5 million to drill a particular well. In order to accommodate a $12,500 contribution per investor, the operator would need a whopping 200 investors! No operator would take on even 30 investors for a well that size. By pooling with Gulf Coast Midwest, GCMW investors achieve a level of diversification they could not achieve on their own.
Economies of Scale - The easiest way to understand economies of scale is by thinking about volume discounts: in many stores the more of one product you buy, the cheaper that product becomes. Gulf Coast's larger investment levels afford it lower well costs than typical retail programs.
Professional Management - Investing with Gulf Coast gives our investors professional financial and operations management and the experience needed to select and maintain successful relationships with oil and gas operators.
Gulf Coast Midwest Operator Partners
Access to Many More Investors - The pool of investors allocating $250,000 to $1 million to the oil and gas sector is much larger than the pool of investors allocating $5 to $20 million.
Experienced Capital - Top tier operators don't have trouble finding investors. They are looking for experienced, steady partners to work with for the long term. Gulf Coast brings the experience and long term relationships needed to fit our operator's needs.
Opportunity -Gulf Coast Midwest brings its operating partners together where opportunities arise. Our exposure to many quality operators often brings opportunities for multiple parties to work together developing a property.
Proper management of financial risk is the key to successful investment in oil and gas. Gulf Coast's business model built around defensive diversification adds value to both our investors and operating partners. to request more detailed information about Gulf Coast's programs.
