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Investing in Oil & Gas DPPs

(Direct Participation Programs)

Is now the time to consider diversifying your portfolio by adding a small oil and gas
component? What do I need to know about a direct investment in oil and gas? What are the
caveats, risks and the opportunities? What is a Direct Participation Program (DPP)?

Why invest in oil & gas? Here is a summary of benefits and reasons to invest:

• Some choose to invest because oil & gas can act as a hedge against rising prices. In the
simplest of terms, if petroleum prices are high and you are paying a lot more at the gas
station than you would like, this can be offset by the returns you can get from an
investment in oil and gas.

• Some investors choose oil & gas as a hedge against movements on stocks or interest
rates. Despite similar volatility, equities and commodities have rarely fallen in the same
year – they tend to move in opposite directions. With markets roiling from uncertainty,
investors looking to dodge some of the volatility might benefit from putting their money into
one of the most volatile asset classes around -- commodities. Sounds counterintuitive, right?
Chaotic trading on the Chicago Mercantile Exchange floor, futures contracts, speculators. The
terms don't exactly bring to mind the predictability so many investors seek. But for long-term
investors desiring insulation from price swings in traditional assets, such as stocks and bonds,
moving some money into a broad basket of commodities -- wheat, oil, cattle, precious and
industrial metals -- could be a good bet. Experts tout commodities as a good hedge against
inflation because the price of raw materials tends to rise with the price of the goods they're
used to make. They also point to their historically negative correlation with the price movement
of traditional assets. As Mike Brown, first vice president of investments for UBS Financial
Services in St. Louis, put it, it's an investment "that zigs when others zag." Other analysts agree
that, used correctly, commodities can help protect a long-term investor's portfolio from shifts in
the prices of their other assets. Putting some money into a number of different commodities
can reduce your portfolio's overall volatility and still get returns similar to a portfolio with just
stocks and bond

• Other investors choose an oil or gas investment because they see that these
commodities are in low and finite supply with rising demand, and the trends continue
upward. Oil & gas are commodities, and commodity prices have recently been driven
higher by a number of factors, including increased demand from China, India and other
emerging countries that need oil, steel and other commodities to support
manufacturing and infrastructure development. Said in another way, when there is high
demand (whether it is sudden, expected or unexpected) and it strains existing supply or
production, buyers compete for the scarce supply and prices rise.

• Some investors want to invest to add diversification to their overall holdings. While
diversification does not guarantee against loss, it is a key strategy used in financial
planning to spread risk. The goal is to make investments in a number of different asset
classes, each with their unique risk reward characteristics, so that when one asset class
is out of favor the other(s) will not be directly correlated and still maintain growth
potential. It might be helpful to think of this like a teeter-totter. Ideally you will have
one asset class on each end where they move in opposite directions. But the more
similar the investments, the more they tend to move in the same direction until you
have both investments on the same side. While they may move at different rates, they
generally move in the same direction at the same time.

• Potential payback on drilling programs. The payback rate will obviously vary with the
price, structure and success of the program. Returns are not guaranteed, of course.
Because oil and gas are depleting assets with nothing left at the end, it is essential for
potential investors to understand that their return of principal, or payout, comes back
to them during the initial years of production. Then the declining yield curve will kick in,
with diminishing returns each year. Many programs would be economically attractive if
oil price would fall greatly though pay back would take longer; make sure to study
offering memorandum and the sensitivity studies with your advisors.

• Many investors choose a drilling program because of the generous tax benefits
available. Most oil & gas investments have some tax benefits, while drilling has much
higher benefits not available in the tax code to other types of investments. Details on
tax benefits are found in the Tax section (can provide a link here)

What are reasons NOT to invest? What are general risks and caveats?

• Oil & gas investments can be volatile. Cash flows are tied to two main variables — the
price received for, and the amount of, oil or gas produced and sold. The supply and
demand curve, as well as the actual functioning of the wells, which includes both the
cost of maintenance and the amount and quality of the production, affect cash flow.
Price is affected by a myriad of issues; political, economic, weather, and supply-demand
just to name a few.

• Type of ownership. There are several different types of ownerships (limited partnership,
general partnership, LLC, etc.) that may be encountered, but one common type is as a
general partner. In contrast to a limited partnership, where the liability is limited to the
amount of the investment, a general partnership has no such limit to its liability. If the
expenses exceed the income generated by the investment, a general partner may have
to bring in additional money to fund the shortfall. A general partnership is not an
appropriate ownership type for all investors.

• Risks tied directly to the sponsor/and or company in charge of drilling and operating
the wells – their success will be your success. It takes more than high oil and gas prices
to make money! Knowing the background and track record of the company – who you
will be doing business with – is very important in the due diligence before choosing to
invest.

• Drilling issues and other problems that can occur (i.e. a dry hole or uneconomic hole,
delays due to weather, teams on the ground awaiting drilling rigs, etc.). Drilling
programs that are in proven fields or next to producing wells are called development
programs, and are considered less risky than experimental programs (‘wildcatting’).

• Oil and gas are depleting assets. Typically one invests, gains the cash flow and tax
benefits, and owns the interest until the wells runs out or become uneconomical to
produce. Typical life of an oil well can be 20 to 30 years, with declining returns after
perhaps the first few years, depending on location and other factors. Sometimes the
wells or property are put up for sale after a few years; others times they may not. Make
sure you understand the “exist strategy” for any investment you are considering, if
there is one.

• Relatively Illiquid. Some oil and gas shares can be sold or resold in an auction style
situation, however, any investment that does not trade on a major exchange should be
considered illiquid and long-term.
• External economic and political events affect oil and gas pricing and availability.

Because of this volatility, an investor should have a high risk tolerance. Among energy choices,
there are varying degrees of risk: while all should be considered high in risk, royalty programs
are generally more conservative while the most speculative are the experimental drilling
programs (as opposed to developmental drilling).

What is a DPP?

A Direct Participation Program or DPP is an investment program designed to let investors


participate directly in the cash flow and tax benefits of the underlying investment. Investors
own a percentage interest or units in the offering or a share of the actual assets of an operating
company, and receive directly the cash flow and tax benefits from their investment.

So for instance, if you buy an energy stock, you are a stockholder of the company but the
actions, tax write-offs and net cash flow are all received by the company itself, not the
stockholders directly (you can’t write off drilling costs on your own tax returns, for instance).
The energy companies often reinvest profits back into development, exploration and growth,
effectively giving away control of your profits. Not so in a DPP. The pooled investment monies
are used for the program’s goals, such as drilling, extracting and then selling oil and gas for the
cash flow, or acquiring producing wells or mineral rights with royalty payments. The advantage
of this is that you get the benefits of being an owner without having to set up a company or
become an oil expert, which is the role performed by the programs sponsor. You receive
revenues, you directly deduct expenses, and you receive your tax benefits (depending on the
type of program, these benefits vary). While each program has a stated investment goal, there
is no guarantee the stated investment objective will be achieved.

DPPs are generally available only to accredited investors – that is, investors with a net worth of
one million dollars (or salary of $200,000 for two consecutive years), sold under what is called
Regulation D. Suitability for any investment is also necessary.

This is not an offer to buy or sell any security. Securities are only offered by PPM to accredited investors. Investments are highly speculative,
subject to up-front fees and expenses that may impact investor returns and outweigh the tax benefits, are generally illiquid, the stated
investment objectives may not be met, appreciation and income are not guaranteed and there is the potential for the loss of principal invested.

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