Energy Investing: Favorable Policy Changes Adjust the Map, Not the Mission
Despite a favorable environment for the oil and gas sector under the Trump administration – driven in part by expanded drilling permits; a massive expansion of liquid natural gas exports from the United States due to geopolitical events like the Russia-Ukraine war; and distance from the environmental, social, and governance movement, which characterized the post-COVID/Biden years – the investment case for energy must be clear and paramount.
Adam Dooley, president of Waveland Capital Partners and an active sponsor of oil and gas investment programs, noted during a webinar hosted by AltsWire that while policy changes like that of the current landscape create “big tailwinds” and improve market access by reducing bottlenecks, they ultimately “adjust the map, but not the mission” of investment.
Investment decisions in the energy sector are not treated as “pure price bets” or market timing exercises. Instead, the investment case must be determined by rigorous asset-level underwriting and should be based on conservative base cases while assuming timelines may slip.
Brad Updike, a partner with third-party due diligence firm Mick Law and an expert on energy programs, told AltsWire’s viewers that advisers should be strategic as they allocate to energy within client portfolios. Given that oil and gas is the “sixth biggest sector of commerce” in the United States and the “feedstock for the top five sectors above it,” accounting for $1 billion in daily oil and gas gross revenues, “I think it would be irresponsible for any adviser not to include energy, oil, and gas within their retail investors portfolio,” but it should be “a component of an alternative investment slice.”
“For the investor that has $2 million of investments, if you believe in the 20% rule that 20% of that should be allocated to alternative products, your energy sleeve of the alternative slice might be $50,000 to $100,000,” Updike said. “It’s going to be a product that complements the other investments within that alternative investment suite.”
Key criteria that must be clear for every project include geology, costs, operator quality, and the quality of the specific basins. Dooley emphasized that this strict underwriting process is unchanging, regardless of current events, stating that projects are underwritten the same way today as they were three or four years ago.
“We also have to think about hedges mitigating risk not dissimilar from real estate, quite frankly,” said Dooley. “It reshapes the exposure, and when we look at [how] a real estate portfolio would look at a tenant mix or submarket quality, we’re looking at operators and basins.”
In considering other real estate and real estate investment trust terminology to help advisers interpret the metrics of oil and gas programs and have impactful conversations with their clients:
- Property operating expenses are similar to the “lease operating expense,” covering power, water disposal, and other necessary chemicals;
- Decline curves can be likened to a lease roll schedule or the natural tapering of occupancy/throughout a real estate transaction; and
- Strip pricing, the forward curve for the price of oil over the short and intermediate term, is “a lot like market rent comps projected over time.
The webinar sought to explain and actualize energy investing’s role within alternative investment portfolios.
For financial advisers exploring retail energy investment opportunities in the oil and gas sector, programs generally fall into two basic categories: exploration and production, or E&P, programs that actively drill wells; and programs focused on acquiring mineral rights and royalties.
The E&P drilling program universe itself is divided based on who manages the actual well operations:
- Operated drilling programs are partnerships where the sponsor is directly responsible for drilling and operating wells. Typically marketed to retail investors as having major tax advantages, sponsor compensation is heavily driven by carried interest along with front-end management fees. These fees help the sponsor recoup their costs for the leasehold investment made prior to syndication.
- Non-operated drilling programs are where the wells are operated by major oil and gas companies. These large companies often sell some of their working interests into a segment of the E&P universe known as the non-op deal market, which is valued at approximately $10 billion to $25 billion. In this model, the sponsor deploys investor capital to acquire working interests in wells.
Royalty acquisition programs focus on acquiring existing resource rights rather than new drilling. Many royalty programs use a direct title type of structure enabling the interests sold to be used as replacement properties for Section 1031 like-kind exchange planning purposes.
Royalty acquisitions allow investors to claim depletion deductions. It’s a substantial investment tax feature, according to Updike “because it enables these investors to actually take 15% off of their allocated oil and gas production revenues … similar to real estate depreciation, but actually more powerful in that you can actually continue to use percentage depletion even after your basis is at zero.”
Video Transcript
Damon Elder 00:01
Hi, I’m Damon Elder, publisher of AltsWire. Thank you for joining us, to learn more about energy investing, I’m joined by Brad Updike, a partner with Mick Law, one of the leading third-party due diligence firms in the alt space. Brad is also an expert on energy programs.
We’re also joined by Adam Dooley, president of Waveland Capital, an active sponsor of oil and gas investment programs. Today, we’re taking a deep dive into one of the fastest growing asset classes in the alternative retail channel, energy.
Over the last several years, investments by retail investors and energy programs have grown exponentially, yet many advisors lack awareness of the potentially substantial benefits and risks that these investment types can provide.
Today, we’re going to shed some light on these programs, the risks and the potential rewards. So why don’t we start, guys? I’m just going to throw a general question out there. You know, why is now an important moment for us to be discussing energy, in terms of the alternative investment universe? Brad, why don’t you start off?
Brad Updike 00:57
I think we need to talk about the capital discipline era of oil and gas, which began about 2018, 2019. And during this period, and actually from then to now, we’re seeing stockholders and major oil and gas companies, they’re requiring these exploration and production companies, E & P companies to do three things. These companies are being required to reduce their debt. They’re being required to pay higher dividends to the stockholders, and they’re being required to drill new wells out of their existing cash flow. And while this is going on over the last five- and six-years banks, we see banks that have traditionally been heavy energy lenders, they’re tightening their lending standards while they’re also commanding strict enforcement of, of loan covenants.
And on top of that fossil fuels has come into disfavor, or it came into disfavor with private equity over the environmental, social and governance movement. And as an example of that you know, we see private equity firms go from deploying about $40 to $50 billion annually in oil and gas pre-COVID to about 10, to 15, 20 billion during President Biden’s administration. That’s 2021 through 2023; we have a 60 to 70% reduction in private equity investing in oil and gas. So as a result of that, a couple of things emerge. First of all, cap rates on acquisitions of producing oil and gas assets have come way down from 8% to 12% pre-COVID to now where, we’re seeing those cap rates at about 14% to 18% over the past two years for these producing assets.
And then a second significant development, I think has emerged where these exploration and production companies they’ve actually re been able to replace the private equity capital that was lost with other capital within the non-operated working interest deal market, which coincidentally a number of our oil and gas sponsors that participate in where they deploy capital.
Adam Dooley 03:24
Over the last 24 months, there has been some significant geopolitical shifts. And one of the major events has been the war between Ukraine and Russia. Russia and the supply of liquid natural gas from Russia into continental Europe, and specifically through Germany. And that pipeline actually blew up and exploded. The US stepped in and filled a huge gap in Europe with liquid natural gas. As the Trump administration had come in, and they put more emphasis on base load power, oil and gas, nuclear energy and they have been less favorable toward renewables, but renewables certainly from our perspective, are not going away. It’s always going to fill in a gap, but that base load power based on geopolitical shifts plus what’s happening in AI computing and data centers, the demand for energy is only accelerated. Goldman Sachs did a study recently that for the first time, since they’ve been tracking it, the demand for energy could outstrip supply by 2030. They’re not suggesting it will, but it’s just there’s a lot of tailwinds in the space right now.
I think that along with the backdrop that Brad just described, and if you look at the private wealth channel where financial advisors are working with individual clients to manage portfolios, the other shift that has happened over the last seven, eight years and potentially particularly post-COVID, is interest rates. Interest rates went to near zero. They’re up nearly threefold in the last five to six years. And where advisors and clients who were looking for cashflow and income were able to pivot toward real estate assets and reach specifically, as rates have expanded and increased over that timeframe, it’s been more difficult to pencil real estate projects, because more often than not, they’re relying on debt to make those deals work. And as interest rates have spiked, it’s been more difficult to make that math work.
And I think as a result of that, private credit has stepped in secondarily energy, conventional energy, oil and gas minerals has also stepped into that gap. And there’s been a recognition over the last three, four years that this is a place, particularly oil and gas, where there’s not only durable cash flows and income, but it does come with some pretty significant tax advantage as well, because the IRS and the US tax code favors and encourages the domestic energy supply.
Damon Elder 06:16
So given that backdrop with the geopolitical things that have been going on in recent years, the technology booms, particularly with AI, we know is a major draw on the energy side of things. You know, how have you seen advisor interest in energy then evolve over the last few years? You know, given that backdrop?
Adam Dooley 06:36
So, Damon I think it’s a great question, and we see this in the marketplace day in and day out at Waveland because we’re working with financial advisors and hearing what their clients are saying. And what we hear is the need for durable cash flow hasn’t changed. And they want something that is non-correlated, and specifically it’s not going to live and die with the S&P 500 or interest rates. And energy is a real asset cashflow stream. The supply discipline there has been better than in past cycles. The reporting’s much clearer. It makes it easier to underwrite with the same rigor that you would use in other alternatives. And as a result of those dynamics, advisor interest has peaked.
And where we’ve seen a big shift is it used to be viewed oil and gas as a tax perk. People that are looking for tax advantages at the year end, and there’s certainly a need for that, and there’s some, some terrific drilling programs for that. But it was, it was viewed in that category. It was a curiosity, a part of portfolio construction, really a tax mitigation tool.
Advisors now are building income from real assets, and there’s an energy sleeve that sits next to core real estate infrastructure and private credit. From our perspective, that’s been the biggest change the last three to four years.
Brad Updike 08:04
Just the final observation about the opportunity today for advisors. I would just say in looking at and evaluating oil and gas private programs over the last 17, 18 years, I would just point out that the investment program structures, I believe they’re improving a lot on their costs and sponsor compensation. I think a lot of that has to do with regulation BI, which now requires a lot of these sponsors to be mindful of their costs and their sponsor compensation.
I also think that today we have more program sponsors that are institutional quality in nature, just in view of just their acquisition resources and just their balance in their management teams and the quality of drilling and royalty products that they’re pursuing. You know, you go back 15 16 years ago, 2010, the quality of sponsors that were actually marketing and syndicating their programs to retail advisors, it was a much different environment back then.
In 2010, we had about, we underwrote about a billion dollars of debt and equity capital by 30 different sponsors. And half of them were promoters, and they were completely actually outsourcing their operations and acquisitions to other companies. Today we’re seeing a lot less than that, less promoters and more real oil and gas companies, that actually control their operations and acquisitions.
Damon Elder 09:40
Well Brad, let’s stick with you then. I want to talk a little bit about really, you know the basics of oil and gas investing, energy investing. Because, you know, it is a fairly complex space, like a lot of alternatives, but I think particularly so, a lot of advisors maybe might be interested in energy investing, but don’t quite understand maybe some of the nuances. So why don’t we talk about it a bit you know, for advisors who, who aren’t real familiar with energy investing, oil and gas minerals, etc. You know, what types of investment structures are most common today?
Brad Updike 10:11
For advisors out there that are trying to get their hands around the retail oil and gas investment opportunities. There are really two basic types of E & P programs, though there are those that actually drill, that use investor monies to drill wells. And then there are sponsors that are deploying the investor dollars to acquire mineral rights and royalties.
And within the drilling program universe, you have operated drilling programs. Those are partnerships in which the sponsor is actually drilling and operating the wells, and where they’re actually driving much of their compensation in the form of carried interest, as well as front end management fees, which help to compensate them for their leasehold investment that they made into the project prior to the syndication. These deals are also typically marketed by retail advisors for their tax advantages. And then you also have the non-operated drilling programs where you have the sponsor that’s deploying investment capital to acquire working interests in wells that are operated by major oil and gas companies that sell some of their working interests within this vibrant non-op deal market that I had talked about earlier. This is again, about a $10 to $25 billion segment of the exploration and production universe. And it’s a segment where our retail sponsors have been fortunate to be able to participate in.
And then you also have the on the other side, the royalty acquisition programs. Many of these programs are structured with a direct title type of structure, which enables the interests that are being sold to be used as replacement properties for section 1031, like kind exchange planning purposes. The royalty acquisitions also enable the investors to claim depletion deductions, and that’s pretty powerful investment tax feature because it enables these investors to actually take 15% off of their allocated oil and gas production revenues, pretty powerful. It’s a pretty similar to real estate depreciation, but actually more powerful in that you can actually continue to use percentage depletion even after your basis is at zero.
Damon Elder 13:01
I know tax advantages are one of the primary drivers of interest in oil and gas, and we’ll talk a little bit about that in a moment. But I want to go back to Adam, you know from somebody who helps to distribute and sponsor retail programs in the energy sector, you know, what are the primary benefits that investors and their advisors are seeking when they’re allocating to oil and gas and other energy programs?
Adam Dooley 13:25
Damon, that’s a great question. Thank you, what I find from an overall perspective working with advisors and their clients is they have universal needs, which is income growth, diversification and obviously to do it in a tax efficient manner. As it relates to oil and gas in terms of a portfolio construction, depending on the structure as Brad just outlined, is some people will be going down the path of a total return approach where they’re receiving income and cash flow that’s uncorrelated largely to interest rates and maybe property values and then have growth on the backend after a fund goes full cycle. There are tax advantages associated through those total return programs. Secondly, it may be more of an emphasis on a tax situation and trying to mitigate a specific tax position in that client’s portfolio. In those cases, a drilling fund may make more sense. And as of the last couple years, putting the opportunity zone wrapper around some of these oil and gas structures has been really beneficial because a lot of the oil and gas assets happening based in designated opportunity zones. So that’s something that has become more popular as well the last 24 months.
But the clients specifically it’s income, you know, akin to a dividend yield sourced from the production cash flow diversification, it is typically there’s a low correlation to traditional stocks and bonds or property values or the interest rate beta. And then with the tax efficiency, advisors have become very comfortable with real estate over the last 10 years. And I think clients intuitively, particularly their high-net-worth clients, understand the tax benefits from real estate. Oil and gas provides many of the same intangible drilling costs and depletion, they function a lot like accelerated cost recovery or depreciation in real estate. They’re just using different terminology to achieve the same tax efficiency.
So, from, from the perspective of clients and advisors, it’s really, I think, those three legs of the stool. It’s the income piece growth or tax efficiency, and where they’re putting the emphasis on. And depending on that emphasis, then they’re going to choose the program and structure of that program based on the outcome they’re trying to achieve.
Damon Elder 15:58
Let’s talk a little bit more then about tax advantages, because obviously in the Alts world a lot of these programs are structured, you know for tax advantage purposes. And then a lot of advisors and investors rely on 1031 exchanges, opportunity zone funds, etc. Just general real estate really for the tax advantages sometimes not even all that concerned about the income or total return tax advantages can drive a lot of equity in these programs. I know, again being a lay person, not an expert on oil and gas, but I know that one of the most attractive qualities of these programs are the tax advantages. So, Brad, can you kind of summarize what those are and really what, what advantages can accrue to investors from a tax perspective in these programs
Brad Updike 16:42
For drilling pass throughs of intangible drilling costs, i.e., IDCs and depletion are the main income tax features within the drilling programs, retail syndicated drilling programs, intangible drilling costs are the unsalvageable drilling costs items. That’s your labor, water, chemicals, sand, it’s drilling cost items that are going to be perishable during the drilling process. And these make up about 75% to 80% of the total, drilling budget. And the good thing is if certain deadlines are met, certain requirements are followed, the investors share of that intangible drilling cost allocation, it’s going to be deductible in the year that they make their investment. And in some cases, it can be pretty significant. It can amount to 70, 75, 80% of the taxpayer’s investment, which effectively reduces the cost of that investment from a tax sufficiency perspective, maybe from $100,000 at face value to maybe 65, 70, $75,000 on a tax adjusted basis. When the IDC, the intangible drilling costs are actually factored into the equation.
The depletion allowance, I talked about that earlier in the presentation, it operates very similar to what an investor might get in a real estate investment like depreciation, but it’s more powerful. It actually enables, if the program is utilizing percentage depletion, it enables each of the retail investors to deduct 15% of the gross oil and gas production revenues that they’re getting. So from a tax efficiency perspective, although their distributions from oil and gas are being taxed ordinary income tax rates, because they’re being able to deduct 15% from the gross oil and gas revenues that they’re allocated, it actually gives that product a tax treatment that would be very similar to dividends, qualified dividends that they might receive from a stock company.
And then I had talked about this earlier, but within the royalty programs, if certain structural requirements are met if the program is structured as a direct ownership type of program, then 1031 planning opportunities could potentially be available, in which case those interests that the retail investors are buying from the program they could be used as replacement properties for like kind exchanges. And in addition to that within these royalty programs, the investors are also getting the benefit of that 15% depletion allowance deduction as well.
Damon Elder 19:47
So, I mean, there’s, again, just inherent within these energy programs, there are significant tax advantages, but then you can also pair them with things like a 1031 exchange, opportunity zones, obviously in the big, beautiful bill, there’s greater advantages. And as Adam pointed out earlier you know, we’re going to get an even better rural benefit for, and obviously oil and gas, you don’t see a lot of oil derricks, you know, next door to a Walmart. They’re usually out there in the sticks, which are going to be rural areas. Right. So, I mean, again, just inherent within these programs are fantastic advantages. And then there’s these others that you compare them with, is that right? Adam?
Adam Dooley 20:27
Brad makes, a good comment. I also think it’s one of the major misconceptions of oil and gas within the advisor community that it’s solely a tax play. There are certainly tax advantages to these programs and drilling, which Brad mentioned has probably provide some of the more powerful tax advantages. But overall, this is a component. These are still real assets that can provide income and growth and, and that’s how they should be viewed first. And what, what are the advantages of the program pre-tax? How are these programs being underwritten? What’s the institutional quality of the program? And then look at the advantages through the lens of taxation. But you’ve got to underwrite a quality program first,
Damon Elder 21:13
Right? You got to, I mean, tax advantages are fantastic, but if the investment’s a dog, it’s a dog. Right?
Adam Dooley 21:19
Right. Exactly.
Damon Elder 21:21
Okay, well why don’t we pivot a little bit Adam, we’ll stick with you. Obviously, you know inflation, market volatility, those are always considerations from any advisor’s perspective that obviously can have a significant impact on their investors. So, from your perspective you know, how do oil and gas allocations perform in relation to inflation and market volatility?
Adam Dooley 21:42
Damon, what we find is with regard to inflation, it’s important, these are commodities. They’re linked to the physical demand for power, transport, petrochemicals and they respond differently than financial assets. So, in an inflationary or a volatile equity environment, energy’s going to provide the potential to add a counterbalance. But as we said earlier, you still have to focus on the underwrite quality, cost control, and oftentimes that matters more than the big macro backdrop. Today we’re sitting in a situation where oil is at a 10-year low. And from our perspective in a non-op strategy, we haven’t seen an acquisition opportunity in this window as good as this in the last 10 years. But having said that, we’re going to deploy capital on a monthly basis, and prices will rise and they’ll rise over the course of a 12, 24, 36-month period. We don’t know where the commodity prices will be any given month or maybe six months out, but we have to factor in when we do underwriting is we know where assets are valued at today, and they’re at historically attractive prices.
We know they’re also going to rise, but historically what we found is if they’re between a bandwidth of 55 and 75, it works in our model pretty attractively. And I think a lot of oil and gas programs would say the same. And then the flip side is when you harvest those assets and package up a portfolio and sell them on where oil prices at that point, and that can dictate what the growth component is, or depending on the structure of the program, when capital is returned to the investors. So certainly, the value of the commodity price is of course, important, but there needs to be a recognition that that commodity price is going to change not only daily, but month to month. And so, we’re underwriting based on where we believe, and the market believes those assets will be 2, 3, 4 years out based on historical trends.
And, and that’s the important piece because the other element from an investor’s perspective is they’re seeing these assets not priced to the current market. They’re seeing these assets in most cases, certainly in Waveland’s case, but most cases of our peers at the space at the value what they were purchased. And if they’re in a program that pays income, they’re receiving that income and they’re not often the values reset based on that current commodity price. So, it can be a deceiving situation where a client looks at the value of their asset and thinks I put in $250,000 in this program, and a year later it’s still valued at 250. That’s not always going to account for the value of the portfolio based on current assets, where current commodity prices are that single day, whether they’re more or less. And they’re really given that most of these are structured as private placements. They’re looking at income they’re receiving or potential tax advantages they’re receiving. And then when those programs go full cycle and return capital to their investors, that’s when all of the assets will be valued at that point in time.
Brad Updike 25:17
I would just add to Adam’s comments, price costs, their stability, actually their instability over the last 15 years. I think I could say that yeah, the instability and pricing and costing has had a tremendous effect on sponsor underwritings of projects. It goes without saying, we’ve had four pricing cycles over the last 15 years, which were followed by four Cap X cycles to boot. We had the great recession in 2015. OPEC floods the market; we go from a hundred dollars oil to $30 oil in about five months. We’ve gone through COVID, and now we have this 2025 cycle with Trump’s tariffs and his commitment to kind of reset the economy.
As a result of those 15 years of incredible instability in pricing and costs yeah, you see a very mixed level of prior program performance among the retail sponsors. And as a result of that pricing and Cap X instability, I believe the retail investment focus has become more educated over the last 10 to 15 years. And I believe that broker-dealers and RIAs that are receiving our legal opinions, I believe they’re looking much closer at our underwriting models within our opinion to see just how much stress a lot of these programs can take in terms of pricing and cost.
I think it’s also shifted the retail investment preference in these broker-dealers and RIAs that we represent away from conventional and riskier drilling projects to more horizontal drilling by operators with real scale good net capital and optionality within their operations and structures.
Damon Elder 27:21
Brad, in some of your writings, and I’ve heard you speak on this, you know, you’ve called our current period a quote unquote new beginning for oil and gas. What makes 2025 and beyond different from some of the past cycles you just referenced?
Brad Updike 27:34
Couple of different developments come to mind. First of all, we have better stabilized prices for natural gas, and I believe that is the result of the market sentiment as to how much natural gas consumption we’re going to be using over the next several years. I know we’re at about 105 BCF per day in usage in the US today, but based on LNG liquified natural gas exporting facilities that are going to be coming online over the next two to three to four years, and in data center construction as well as just the gradual electrification of our auto fleet we’re expected to bring on another 20 to 30 BCF per day in natural gas usage over the next three to five years. Coincidentally, we’ve gone from a pricing level of about two to $2 to $2.50 cents in MCF. Those are the prices that we saw over the past 5, 6, 7 years to a point now where the market is actually pricing $3.50 to $4.00 and sometimes higher as the new pricing level for natural gas.
I’d also mention that the retail channel now has access, I think, to better institutional quality assets and sponsors. As I mentioned before, the capital discipline era that we talked about that’s come to play into fruition over the last five years. It’s actually created a non-operate working interest deal market where private equity was replaced by other forms of capital in which a number of retail sponsors including Waveland Energy, we’re able to maybe step in and fill some of that void.
Damon Elder 29:37
So, Adam, again, talking about some of the policy changes that Brad’s already touched upon, and you’ve touched upon as well. How have these policy changes such as expanded drilling permits that have, we’ve experienced under the Trump administration, certainly a much more favorable administration, when it comes to oil and gas exploration, and then also liquid liquified natural gas exports. As we touched upon given the Russia, Ukraine war, etc., we’ve really seen a massive expansion of LNG exports from the US. How have these changes impacted opportunity in the sector from not only an investor’s perspective, but from an operator, from a sponsor’s perspective?
Adam Dooley 30:18
Great question, Damon. And this is something that we’re asked often. More permits and export capacity. It reduces bottlenecks and improves market access. But we still have to price these projects off of conservative base cases, and we have to assume that timelines can slip. So, in our view, policy changes adjust the map, but not the mission. The investment case still has to be clear. It’s got to be clear on geology, costs, operator quality in our specific situation, because we’re partnering with big global operators and the investment case still has to pencil. And these are not pure price bets, its asset level underwrite. And that’s probably a misconception of people will think, well, oil prices are here today, is that good or bad? It’s neither. This is asset level underwriting and not market timing. We also have to think about hedges mitigating risk not dissimilar from real estate, quite frankly. It reshapes the exposure, and when we look at like a real estate portfolio would look at a tenant mix or submarket quality, we’re looking at operators and basins.
I often say to advisors who have become more comfortable with REIT terminology, that understand Cap X and budgets for a real estate pad or a net lease fund you know, authorizations for expenditure AFEs, that is our development Cap X is probably an equivalent or, or the lease operating expense. What’s that going to be? It’s similar to looking at a property Op X power, the water disposal chemicals, the workovers decline curves. People are comfortable with occupancy or the throughput on a real estate transaction. They know these naturally taper, but a decline curve. It’s kind of like a lease roll schedule. And I think for advisors, particularly the ones that have really started leaning into conventional energy and oil and gas programs, they understand that and then it clicks with them and they can have more intelligent conversations with their clients. I think the classic is strip pricing. Somebody new to oil and gas will, what is strip pricing? Explain this forward curve. It’s a lot like market rent comps projected over time. It’s where the market believes oil will be priced over the short and intermediate term.
So, I think we’ve got to look at those in context. So, when we think about inflation permitting, regulatory changes, we still have to underwrite quality projects, whether it’s today, based on the Trump administration who’s really leaning into oil and gas based on the geopolitical dynamics. There’s a lot of tailwinds in our space today, and you read about it in the paper, I was with neighbors recently, and he’s a good friend and he’s in ophthalmology. He works for a large pharmaceutical company in ophthalmology. He knows nothing about oil and gas, and one of the first things he said to me is, business must be booming for you. I said, why do you ask that? He says, because energy and oil and gas is booming. And I thought, wow, here’s a person that I had no idea even understood what we did. So, there is big tailwinds going on in the industry, but interestingly enough, we were underwriting projects three and four years ago the same way we underwrite projects today. And I think that’s, that’s a critical component here.
Damon Elder 34:00
Well, we keep talking about, obviously the, the fundamental need for good underwriting for, for any investment program, but certainly for these oil and gas programs. Brad, how have exploration and production cost trends and pricing stability affected the sponsor underwriting assumptions?
Brad Updike 34:17
Tremendously would be the short answer, because over the past 15 to seven years, I mean, this has been the era of instability in terms of oil and gas pricing and cost trends. We’ve seen four pricing cycles and that’s been followed by four Cap X adjustment cycles as well. As a result of this it goes without saying that the cash-on-cash returns of many sponsors are very mixed and they tend to follow, these pricing cycles.
As a result of this pricing and Cap in X stability, I would say to the retail sector’s credit that their investment focus has become more educated and many broker dealers and RIAs are looking, a lot closer at our underwriting models, in our opinion. And for good reason because when we actually go and do our underwriting, we’re taking the sponsors pro forma kind of as our foundation, but we’re actually doing our own independent research in terms of oil and gas production trends, costs. And we are basically coming up with our own assessment as to what a realistic range of returns are for that project. And we add stress to those models, and I believe the retail investment community is appreciating that.
I think it’s also shifted the retail investment preference away from conventional and riskier drilling and over to horizontal drilling by operators with real scale good net capital and optionality within their operations.
Damon Elder 36:08
You know, we’ve seen capital formation in the retail channel specifically hit record levels last year. It’s very strong again in 2025, what’s driving that growth? I assume it’s a lot of the factors we’ve already talked about, but kind of put a bow around that and kind of explain why are we seeing such greater intensity of capital formation from the retail channel?
Adam Dooley 36:28
We talked about interest rates as a backdrop, and is interest rates increased over the last five, six years post COVID? Advisors and clients have been looking for programs to provide yield, private credit has benefited in a big way from that, but also oil and gas has benefited and layer on top of that, there are better sponsors with more institutional underwriting and quality. So, the advisor channel through private wealth is getting better access, more access, better education. And I think programs have been designed, frankly, to have a better fit toward the retail wealth channel. Waveland in particular. We have a flagship total return strategy that we developed in the last 10 years, and we have iterated to better fit the retail private wealth and advice channels. and our peers have done the same platforms have simplified their allocations the due diligence teams that broker dealers and RA firms have become more adept at reviewing these programs. And there are more independent due diligence reports that have more rigor and Brad, I would say, has done a phenomenal job in the industry and a huge service to the industry with his firm Mick Law of, of helping lead that charge.
We use Mick Law for independent third-party reporting. I know a lot of our peers do as well, and many in the private wealth channel come to rely on his firm’s analysis. So, if you, if you have better sponsors, better education, better fit, and you have alongside that independent third-party reports that due diligence teams can use to review, it helps the entire ecosystem. What hasn’t changed is advisors and clients still have a need for income, and there’s now a clear role for energy within that alternative sleeve as an income-oriented compliment that’s not perfectly correlated with bonds or equities. And those are some of the major demand drivers from our perspective over the last five years.
Damon Elder 38:40
I want to kind of shift a little bit now to portfolio allocation, which is of keen importance to advisors as they’re giving their advice to their clients, portfolio allocation so important. So how should advisors view and think about the role of energy within a diversified alternative allocation?
Brad Updike 39:00
Oil and gas can be used, I think most tactically, but should always be used strategically in a strategic sense. I think it would be irresponsible for any advisor not to include energy, oil, and gas within their retail investors portfolio. I mean, oil and gas, it is the sixth biggest sector of commerce in the US, and it is the feed stock for the top five sectors above it, it accounts for $1 billion in oil and gas gross revenues per day.
But you know, on that point it should be really a component of an alternative investment slice. So, for example, for the investor that has $2 million of investments, if you believe in the 20% rule that 20% of that should be allocated to alternative products. Yeah, your energy sleeve of the alternative slice might be 50 to a 100 thousand dollars.
It’s going to be a product that compliments the other investments within that alternative investment suite.
Damon Elder 40:14
So, Adam, in some of our discussions you’ve described energy as a fixed income compliment. So, what does that mean in real world practice?
Adam Dooley 40:22
So, Damon, I find the industry, whether these are institutional investors or financial advisors serving private wealth points, they’re looking for better risk adjusted returns. And the definition of that is increasing return with less risk. And the asset allocation mix is critical in that process. So as a fixed income compliment, the majority of energy programs are providing income and oftentimes significantly higher income than can be found in an investment grade bond, for example or a tax-free municipal bond. And what we find is advisors incorporating these as a compliment to a fixed income portfolio because oftentimes the income in most cases will be higher. If you think about credit quality of many of these global operators and some of the large independent operators, it’s oftentimes investment grade equivalent and you’re getting a higher yield with an investment grade asset that is not perfectly correlated to change in interest rates.
So, through that diversification process and adding this as part of the income sleeve as a compliment, you create a situation for clients where you are getting a better risk adjusted return in some programs. There’s also the potential for growth on top of that, depending on which style of program that you’re going to use from an energy provider. I also find that as advisors and platforms start to incorporate real assets from an energy and an alternative sleeve. They are exposed to this commodity exposure; they start to ladder commitments just like they’re placing any new allocation. And they may be doing it every quarter on institutional basis, but they’re also preparing investment committee style memos, looking at third party engineering reports, concentration limits, the same way they would look at other assets in their portfolio mix.
So, it has become more institutional across the ecosystem. And there’s a recognition, as we said earlier, these are not just quick tax plays. These are an asset class in conventional energy that can solve different investor outcomes. And advisors are starting to incorporate them more in their portfolios. And I think that’s why we’ve seen, particularly in the private wealth space a three x increase in the flows to conventional energy as an asset class over the last four to five years.
Brad Updike 43:07
That’s a good point. talking tactically about these products, these products have very helpful tax planning features. 1031 features for royalties, IDCs and depletion for drilling. But the underlying program strategy and asset that has to reconcile with the investors’ investment profile and their goals and what they already have their stock and bond portfolios.
And that’s where I think, the value of the cost comparisons and the underwriting comes in play, because we have to validate, these for the risks that these investors are taking and exposing themselves to oil and gas. They have to be able to deliver an outsized return, something that’s significantly higher than what they would otherwise get in a public equity or debt investment.
Adam Dooley 44:01
Brad brings up a really good point, Damon, and I’ve heard it referred to as a second different paycheck. Clients don’t swap out core bonds; they just add a measured slice of energy cash flows that are going to have distinct drivers. And it is far more similar, if you think of preferreds or net lease programs where you’re receiving these steady distributions with different drivers than bonds. Energy’s like lease term with the reserve life and your tenant quality is the operator. But it’s about what’s that Cap X discipline look like, and again, how do you underwrite the asset?
Damon Elder 44:40
I want to go back to Brad real quick and from a due diligence lens, Adam brought up a little bit earlier a term that we hear over and over again in the retail alts channel, which is institutional quality. Now that’s an undefined term, i t can certainly some of these institutional quality programs many people would say well, they’re not very institutional quality. But again, that’s a, it’s a term that’s not well-defined.
Some of the new operators in this space come from the institutional background, and we certainly have seen an improvement throughout the Alts world in the quality of the programs that are coming. But from your perspective, Brad, from a due diligence lens, what defines institutional quality when it comes to energy offerings?
Brad Updike 45:25
We look at it from two perspectives actually, by the quality of the operator that’s actually supervising the drilling and the acquisitions. And then we also look at it from a lens of just the cost, the fee structure, and the ability of those assets to deliver an outsized return to the retail investors to compensate them for their exposure to oil and gas.
In terms of operator quality, we’re looking at the companies that actually would be investment worthy from a private equity institutional perspective. These are going to be companies with strong balance sheets, excellent liquidity, they’re going to be companies in shale plays where you have predictable oil and gas reserves, companies with scale that have two to three to five years of readily available drilling inventory. They’ll have scale in their operations and within their balance sheets, they’ll have the ability to control the flows in the production of the oil and gas during difficult times. They’re going to have their debt under control and then most importantly these companies are going to have well-balanced management teams in the key phases of oil and gas operations, and they’re also going to have a proof of concept. They’re going to have a demonstratable level of good prior performance in the area where investor dollars are actually being invested.
In terms of the underlying assets, so we’re going to take a look at the structure of the program, how it compares to the institutional program counterparts, as well as the retail programs within that peer group. And then we’re also going to perform some independent underwriting of the assets using our own experts in conducting our own costs and reserve analysis.
Damon Elder 47:45
Okay, great. Thanks Brad, before we move on from this allocation discussion, I wanted to ask Adam a question about how should advisors be communicating to their clients in regards to the diversification benefits of energy?
Adam Dooley 48:00
What I find Damon, the advisors the most knowledgeable in the energy space when they’re speaking with their individual clients, they’re focused on the macro backdrop of energy and conventional energy as an asset class, first and foremost. That energy, like real estate or individual stocks and bonds make up a portion of a diversified portfolio. Historically, most clients have not had access or commodity exposure directly, and when they understand that oil and gas and also renewables form the backbone of the economy. It is that energy demand is a base load driving not just what oftentimes is viewed as fuel for transport individual cars. It is in everything that we consume every day, plastics, medical equipment, marine transport, aviation. An individual consumer, and an individual client really doesn’t have a full understanding of how often they interact on a day-to-day basis of things that come directly from the oil and gas industry. The phone they’re holding in their hand couldn’t be produced without petrochemicals.
So, I think it starts with very high level, this is a critical component of the economy. And then once they understand, okay, makes sense, energy should be part of a properly diversified portfolio because the different asset classes will interact in different way with one another. And that’s the goal of the diversification, is to smooth out the volatility versus being in one single asset class. Then I think it becomes a question of how do we fill that sleeve? And based on that client’s individual circumstances, are taxes an essential component or is income an essential component, or is growth more of the essential component? Then they can choose the right program, is that a total return program similar to a non-op strategy? Is that a drilling program? Is that potentially a minerals program?
And then they can underwrite based on the program. Who’s working with proven operators, has balance sheet strength, transparency has conflicts, policies, sensible fees clean waterfalls on the back end. So, I do think it starts with making the case of why energy matters in their life and making that real for the client. And then secondly, determining what type of outcome are you trying to achieve? And then the third piece is, okay, what program are we going to plug into that that provides, that outcome that we’re looking for?
Damon Elder 51:02
Well, then let’s move forward. Again, we touched briefly on it, but I want to spend a few minutes talking more about the market fundamentals, supply demand, the impact that AI is having from an energy perspective. So, Adam, you’ve said that the real story isn’t price, it’s demand. So, what structural forces are behind in undergirding that statement?
Adam Dooley 51:25
What’s interesting about conventional energy defined as oil and gas, the demand has not changed over 50 years. And an interesting stat is that at the time of the Iranian oil crisis back in the late seventies, and you know, I’m old enough to remember sitting in the gas lines where my family had to go on even, or odd days depending on our license plate here in California. At that time oil and gas represented directionally about 78% of the energy supply at that time. Since then, the overall demand for energy has grown significantly, nearly double. And if you look at what percentage of that demand was meant by conventional energy sources of oil and gas, it hovers around the exact same percentage, high 70 percentage points. Renewables have grown significantly over that timeframe, but they still account for less than 15%, depending on which assumptions you use. And which asset class you’re looking at, somewhere between 10 and 15% is meeting the overall demand.
So as fast as it’s growing, because the demand is growing so quickly, which the demand drivers are growth in economy’s growth in wealth. Thirty years ago, China was a very poor country, India was a poorer country, eastern Europe was a poorer region. Today, China’s a wealthy country, relatively, India’s a wealthier country, Eastern Europe, look at Poland specifically. Poland’s economy has become more similar to Spain’s economy. And as wealth increases in these different regions, they want to have the luxuries that we have as Americans every day. Air conditioning, microwaves, appliances in the home, all these things demand energy. So that story is not slowing down it’s only accelerating. Now on top of that, you also have the increase in aviation, global supply, logistics, marine transport, agriculture, farming to feed the growing population.
If you look at oil and gas specifically, which has natural declines and depletion, you have to keep reinvesting just to stay flat, just to maintain stasis within the energy mix of supplying that demand. So that structural picture really matters more to us, and I think the industry than oftentimes the short-term price moves. And, and if you look at some of the new lanes, AI and data centers, those are really power intensive. I mean, there are markets now where natural gas is becoming the default support because they can be turned on quickly, it’s a reliable energy source, it’s relatively clean. I think nuclear in these small modular reactors will benefit more over the course of the next 10 years to provide that need. And, and people are reading in the papers meta, which was formerly Facebook, they bought access to their own nuclear plant to provide power. Microsoft, I believe it’s that three-mile island in New Jersey, but it’s a northeast based power plant. They have a 20-year commitment to drive power for the data centers. These are power intensive data factories, so the demand is only going to increase significantly over the next decade.
Damon Elder 55:19
Sticking with this whole discussion on supply demand, the drivers. Brad, what are those biggest, very variables that advisors should watch from your perspective?
Brad Updike 55:30
As to supply demand variables. First and foremost, I believe that advisors as well as our firm, have to be mindful as to how quickly the drilling Cap X follows price. Because I know that there is this sentiment within our clients, within our broker-dealers and RIAs and their advisors, they want to sell a lot of oil and gas product when oil is at 85 to a hundred dollars. And that’s all good and well but they have to be mindful of the fact that in every up-pricing environment drilling and completion Cap X comes up violently too, and it follows.
And if you look at the prior performance, trends of these drilling programs and even royalty programs that we’ve looked at the times in which oil was 85, 90, 95, a 100, those are the years in which a lot of these programs struggled because they had to pay such high Cap X, such high costs to make those investments.
Whereas, interestingly enough, if you look at, if you go back and look at the drilling programs that were syndicated in 2019 and 2020, during COVID, those years were very good. Those programs are performing very well, and they were able to do that in part because, they were able to deploy those dollars in an environment where Cap X was very low.
Damon Elder 57:06
So, the price of oil isn’t necessarily predictive of the outcome on many of these programs, is that what you’re saying, Brad?
Brad Updike 57:14
It could be actually an indicator of no success actually in the $90 to $100 environment, if you do the math and you go back and look at the cash-on-cash trends,
Damon Elder 57:28
Interesting.
Brad Updike 57:29
Those nine years in which oil was $90, a $100, if you go back and look at the 2011 to 20 f 14 vintage years there were some very horrendous performance trends within the companies that were providing drilling programs to retail investors.
Damon Elder 57:47
I want to pivot back real quick to Adam, you started touching on it but obviously we’ve all been reading and we’ve already all been impacted by the emergence of AI, and obviously we’re data centers have growing in importance as a result. So how really significant is the impact of AI and the data center growth on the long-term energy demand?
Adam Dooley 58:10
Oil and gas are indirectly impacted by AI and data center demand. I think it is common knowledge among people that are in that industry of data center development and what some term AI factories. It’s the transmission grid, the distribution grid of electricity that needs the most upgrades to cope with delivering the power, and it’s significant. It’s specifically why many of these big, large technology companies are buying, and building natural gas plants, nuclear plants to directly supply energy to the data centers.
So, I think the build outs are going to be enormous and significant, and they’re structurally bullish for natural gas in terms of power generation. I think they’re modestly supportive for oil because there’s indirect and regional effects. But just to put some numbers around it from a lot of verifiable high-quality studies we’re looking at, in our organization. Electricity demand globally is going to more than double to 945 terawatt hours with AI workload as the main driver and that could happen over the next 10 years. In the US, data centers could use approximately nine to 10% of the electricity demand in the next five years, and that’s compared to 4% today. So, data center demand on available electricity supplies was 4%, approximately 2024. In six years, that could more than double to 9% or 10%. That’s a huge demand driver.
So, consumption’s going up significantly. Now near to midterm. I think gas is kind of the default base load because use these data centers need a reliable base load power source that’s not dependent on wind conditions, solar conditions they can layer on top of that. I think gas will certainly benefit from that. And if you look at these hyperscalers, they’re looking at renewables and nuclear as long-term solutions, but those take 5 to 10 years to implement. Gas is certainly a beneficiary. Oil is a limited beneficiary, but these structural drivers are going to have a huge impact on not only the economy, but on conventional and renewable energy, in a huge way over the next decade.
Damon Elder 1:01:05
I want to ask, given all that we’ve discussed, what are realistic return expectations that advisors and their investors can have given the current pricing and cost structures?
Brad Updike 1:01:16
Because of the risks that the retail investors are retail investors are undertaking and exposing themselves to the oil and gas segment in terms of operational cut things, we want to see these programs provide opportunities for these investors to achieve an outsized return that’s significantly higher than they would receive with a public product for drilling. When we’re doing our underwriting, our preference would be when we’ve actually factored the offering costs and the sponsor compensation. When we factored all that, we want to see programs that are going to provide a realistic opportunity to achieve IRRs that range 15% to 25%, 30%, and that will maybe return an investment multiple of two over the lifetime of the investment.
In terms of royalties, we’re wanting to see projects that after we’ve applied the offering terms the sponsor compensation, we would like to see these types of programs deliver an investment return retail level at about 11% to 16%, 17% IRR, because again there’s pretty considerable risks that are built into these programs. And because they’re taking on that risk, we feel that through our underwriting these programs these retail investors need to have an opportunity, a realistic opportunity to achieve a return that’s going to be higher than what they would achieve in the public markets.
Damon Elder 1:03:08
Well, let’s talk more about diligence and product quality then. Brad, I’m going to turn to you, obviously you’re one of the top diligence guys in the country and certainly in the sector. What are the key elements that a credible oil and gas due diligence review under Reg BI, what should that entail?
Brad Updike 1:03:24
A Reg BI requires the broker dealer and its advisors to have a reasonable understanding of the cost, the risks, and rewards of a product before they can actually recommend it, before they can put it on their product shelf. So, in view of that firms like ours, we’re going to take a look at the cost structure of a program on a comparative basis, we’re going to not look at it in isolation, but we’re going to actually take a look at the load, the sponsor compensation, and then we’re going to compare that to the peer group of programs, other sponsors that are using similar strategies and that are offering similar products. In our review, we’re going to take a look at the organizational documents. We want to make sure that the investors have good transparency and also fundamental voting rights, and event situation comes in, where the investors as a group would have to take control of the management of that program.
Asset underwriting, that’s going to be first and foremost, is the most important component of our underwriting process, and that is where we actually take the sponsors pro forma, we use it as a foundation, but we actually engage asset experts. We act, we engage engineers and geologists to take a look at that pro forma and to basically come up with our own determination of oil and gas production trends drilling costs and policy operating costs. We do that independent assessment, and then what we do is we make our own pricing assumptions, and then we put together our own independent model, which is going to provide a range of outcomes that we believe are achievable under realistic operational conditions.
We’re going to look at the prior performance of that sponsor company that’s providing the program. We’re wanting to take a look at how those programs have performed cash-on-cash wise in the past, and more importantly we’re going to want to make sure that level of performance that was actually undertaken in the area where money investor money is actually being deployed. We’re also going to take a look at the background of the sponsors. We’re going to look at their experience, and then we’re going to look at the, the balance of the sponsor’s management and whether or not that sponsor’s management is appropriately covered in all of the key areas of oil and gas underwriting. And then what we do is we take that information we go over it over a six-to-eight-week period, and then we put together a legal opinion that tells the broker-dealer or the investment advisor whether or not this is a good competitive program that they should be offering to their clients. And we do that because just Reg BI and the comparative product analysis and the fact that our clients are required to provide, to do these assessments in order to provide good products to their clients.
Damon Elder 1:06:45
Now Adam, Waveland has been around for some time, has a good reputation. So, from your perspective, a sponsor’s perspective, what steps help build trust and transparency with advisors?
Adam Dooley 1:06:57
In my experience, Damon, trust with advisors, it starts with transparency and consistency, of course. And they want to know that we’re operating with institutional discipline. Our reporting’s clear, the structures are simple, our incentives are aligned with their clients. And we make a point of sharing not just the upside in any potential investment, but the risks and assumptions behind our model. And when advisors and their clients can see how we’re thinking about a capital protection governance, the modeling scenarios, the trust builds off of that.
I also think it’s about the communication, timeliness of communication, accessibility to when there’s questions that want to be answered. And, and we as an organization, and I know our peers do the same and Brad’s organization does a tremendous job of it. We invest a lot of time educating advisors. So, they have the best facts at hand with their clients in explaining, conventional energy investments in familiar income and total return terms, in familiar terms that they use every day when speaking with their clients on any particular financial asset.
And how do they connect the performance to these real assets and making ourselves available to answer questions directly. That accessibility always matters.
Damon Elder 1:08:32
So, talking about cost controls and whatnot Adam, what are sponsors looking at and how are they mitigating the risks when it comes to project selection and cost controls, which obviously are fundamentally important?
Adam Dooley 1:08:44
Damon, from our perspective at Waveland, I think our underwriting on individual projects looks very similar to our peers, where we’re focused on the geological risk, the specific basin. But there’s also, what is the fundamental investment strategy? Our fundamental investment strategy for our program is a total return play, income plus growth, and it is focused on an area that Brad touched on, AFE or authorization for expenditure. The other way that I often describe that with financial advisors using terminology they’re familiar with is secondaries. It looks very much like a secondaries market.
And to put an example around it, Chevron, a big major oil and gas firm, they will own huge swath of acreage and assets. And let’s use in our example, the Bach and Shale, which is in North Dakota. Cord Energy, another large oil and gas operator will also own assets in the same geographic location. And oftentimes they own a minority interest already. Conoco Phillips or Cord Energy may own a minority interest, or AFE in a project run by Shell or Chevron, and vice versa. And multiply that across all the basins in the us but then also globally Canada, for example these are global operators. And when a project is commenced and they’re about to go to drilling, let’s assume the example that Chevron is the majority operator, and they will go to, in this case, let’s say Conoco Phillips, they will do a capital call and they’ll say, you have 30 days to meet that capital call. You have a minority interest in this well that we’re about to drill, and it’s $4 million that you have to pay in 30 days. It’s use it or lose it, in these situations.
So, the market that’s developed over the last couple decades and Waveland has been one of the pioneers in this market, alongside other family offices and private equity firms, is to sell on that minority interest as an AFB as a secondary. And so, we will step in, underwrite that specific asset, look at the operator, the actual asset, what we determine the output to be, and then we will bid on it and purchase it. That helps these large global players, manage their own balance sheet risk because they can’t develop on every single asset where capitals called in, nor do they want to lose their interest. So, the AFE is sold on the secondary market, it’s a small institutional ecosystem which we’re a part of.
We step in buy that asset when the underwriting works for us. And in those situations, we’re still underwriting quality of the asset, strength of the operator. Our approach is a target proven reserves, others have different approaches. We are upstream looking at proven reserves with established infrastructure and we’re also looking at the management teams. We need to know that they know how to execute efficiently. And quite frankly, there are groups that we’ve invested with in the past that we will not invest with again.
So, once we’ve gotten through that phase, then as Brad mentioned, what are the operational costs to run these wells? And we’re trying to lock in service costs early design the structures with cap expenses and aligned incentives. Now of course we’re doing that as the minority equity holder and relying on the larger operator who’s doing this. But these are conversations we’re having. So, at the sponsor level, we are co-investing alongside these big global major oil and gas firms. And we’ve got to use conservative assumptions for the underwriting. We’ve got to communicate it openly so when things go great, that’s wonderful, but when they don’t, there’s no surprises. And, and that’s in a cyclical business-like energy, that’s where we’re going to earn long-term trust with our shareholders and investors.
Damon Elder 1:13:04
I want to put a bow around this discussion on diligence and product quality. And I think I’d be remiss, Brad, if I didn’t ask you, what are the red flags that advisors and diligence firms like yours are? What are you looking for? What are the red flags that you’re looking for when you’re evaluating an energy deal? What’s a no go for you guys?
Brad Updike 1:13:23
Due diligence red flags, I think first and foremost when we’re conducting a program level review, it’s important for us to I think confirm the quality of the sponsor’s assets and making sure that the sponsor is actually funding these drilling programs and mineral rights and royalty programs with core assets. And I think we ran into a problem with that maybe 10 to 15 years ago in some of the drilling programs. I think a reason for some of the prior performance fall off in some of those earlier programs was because some companies weren’t quite frankly, actually funding these programs with the core assets. They were using non-core assets. So, we’re going to take a look at that, and that’s goes back to the importance of the independent underwriting and actually looking at the production trends as well as the costs in the programs.
Also, I think sponsor financial condition, that’s a critically important, and I know a lot of times we get pushback and just a lot of some of these sponsors, they have the position that each program kind of stands on its own. So, if something bad happens to the sponsor of the program still survives. We don’t necessarily, I guess, hold to that view. We take a look at the sponsors financials, their balance sheets, their loans. We want to make sure that those loans are current. We want to make sure that the going concern risk at the sponsor level is minimal.
In some cases, in certain of these programs you’ll have affiliate transactions, you’ll have transactions in which maybe one of the sponsor’s programs is selling assets to another program. In that type of instance the independent underwriting, again, is going to be critically important because you’re going to need an independent set of eyes that are going to really, again, take a look at the production and the cost trends on an independent basis in an effort to tell the client, the broker-dealer or the RIA what the real return potential is for this assets. We’re going to look at prior performance and where that prior performance was conducted. And then short-lived reserves, just the nature of what the sponsor is drilling, what reservoirs they’re developing oil and gas from. We’re going to want to take a look at that as well.
Damon Elder 1:16:17
We’ve had a pretty furtive discussion here. I think we’ve hopefully educated a lot of folks, hopefully our viewers have appreciated it. But unfortunately, all good things come to an end. And so, we probably should start wrapping this up. So, I want to ask just a general question to both of you. Feel free to chime in, either or both, what are the two top takeaways that advisors should have from today’s discussion, Adam?
Adam Dooley 1:16:40
Well, first energy’s becoming a strategic allocation. It’s not a tactical trait, I think that’s a combination of the rising global power demand, data center growth, the energy transition. And second, in reviewing sponsors, you know, alignment and transparency matter more than ever advisors are looking for sponsors that operate with institutional discipline, clear structures, predictable cash flow, full transparency on fees, governance risk. And the firms that deliver that level of professionalism, they’re going to earn the trust of the advisors and their clients. And that’s where we’ll see the repeat capital in the private wealth channel.
Damon Elder 1:17:24
Brad, what about you? What are the top two takeaways from today?
Brad Updike 1:17:28
I’ve got a couple of them, better opportunities, better sponsors today. It’s a good time now for the retail investment community to be looking at oil and gas. And then secondly, I think it’s important to get educated and just in terms of that the Mick Law website actually provides multiple white papers and articles that provide guidance and best practices on how to conduct due diligence and how to actually evaluate and underwrite real estate and oil and gas programs. There’s also a number of other publications out there that publish best practice articles and white papers from time to time.
Damon Elder 1:18:16
Great. Thanks Brad. That’s awesome. Adam, again we’re running out of time here, we’re down to our last couple of questions. But I did want to ask you again, you’re looking at the market a little bit different, I think, than Brad probably does as a sponsor. So, what does the next decade look like for energy allocations in this private wealth channel? You know, the pool that you’re swimming in.
Adam Dooley 1:18:38
It’s going to really be interesting for energy allocations in the private wealth channel. We’re seeing advisors and family offices make a big shift from thinking about energy purely as oil and gas exposure, or renewable exposure. Thinking about it as a broader real asset category. And from a portfolio construction standpoint, private wealth channels still incredibly under allocated to real assets relative to institutions. And that’s changing, and over the next 10 years, we expect to see wealth clients increase their exposure to alternatives and infrastructure with energy playing a bigger and bigger role in that mix.
We’ve seen a three plus fold increase the last five years. I would expect to see exact, at a minimum, a three x increase in that over the next five years. And that’s going to be driven first by the search for yield and inflation protection. And secondly, the recognition that energy in all of its forms is at the center of global growth again. We certainly don’t think it went away, it’s just become a narrative that is out there in the mainstream media again.
And whether that’s data centers, electrification, traditional hydrocarbons energy is foundational to global growth, and the sponsors and managers who can deliver institutional quality, governance, transparency, and of course, consistent performance, those will be the ones that attract the most capital.
Damon Elder 1:20:07
I want to end with you Brad. If walking away from this, if you could give one piece of advice to an advisor who is beginning to explore oil and gas investments for the first time, what would that piece of advice be?
Brad Updike 1:20:23
Requests and read the Mick Law due diligence opinions for these sponsors that are providing and syndicating these investment opportunities. Because there’s some incredible information in there just about their competitive strengths in terms of like how their costs and their sponsor compensation systems compare. There’s really good information and they’re just about the assets and the return potentials investor rights prior performance, the management experience, and how it covers the various key areas of exploration and production operations, as well as back good background information as well.
Damon Elder 1:21:10
Before we end, Adam why don’t I give you an opportunity to answer that question as well. What’s the one piece of advice you’d give an advisor who’s just starting to look into oil and gas?
Adam Dooley 1:21:18
Keep an open mind. There are a lot of great sponsors out there and also ask the right questions and don’t get overwhelmed in the terminology because that terminology is very similar to the terminology that they’re already comfortable with. I mean the easiest example is depletion in oil and gas that is the same as depreciation. Very similar, and ask the questions of the sponsors that you’re speaking with, is all of us Waveland included? We have a great relationship with our peers in the space, and we all want to educate the industry more because we know this needs to be a critical component of an asset allocation mix.
And we also all agree when we’re at different conferences and Brad’s conferences that he hosts every year it really comes down to education. So financial advisors understand these programs because what we found, once they understand the programs, they immediately see the value and they begin making allocations. And when the clients start to see the outcomes from those allocation investments, they end up becoming repeat investors.
And I think that cycle creates advisors doing it with more of their clients. And, and that is just this, this virtual virtuous success cycle that we’ve seen. But it does start with asking questions and not being afraid to sound ignorant because you’re new to the space.
Damon Elder 1:22:52
I appreciate those comments, gentlemen and Adam, because I certainly agree with them. I think the oil and gas sector of alts is a very perhaps underutilized and potentially powerful aspect that advisors can make better use of for their investors. And I think, like you said, it all comes down to education, and I want to just thank you guys for sharing your wisdom in this space that I think a lot more people need to learn about.
And of course, as always, AltsWire will keep an eye on the programs that are out there and what the sponsors are doing. And again, I appreciate your insights and I appreciate everyone for tuning into this webinar today. Keep watching and keep reading AltsWire, we know Brad does every day. And we’ll keep watching the news and we’ll keep sharing it with you.
So, thanks again, gentlemen, I really appreciate it.
Brad Updike 1:23:45
Thank you.
Adam Dooley 1:23:46
Thanks, Damon.
