I am an oil and gas landman who began working in the energy industry in the late 1970s. I worked for NYSE listed companies, one major who was in the Fortune 100 and two large independents who were in the Fortune 500. Later on I worked a smaller independents, and I have also operated my own independent oil and gas investment company.
During the first few months of 2012 I worked on a daily basis with Dennis W. Stutes. My primary job was to perform due diligence analysis the Bakken formation prospects that he wanted to acquire. Along with this I handled negotiations with some of the companies who wanted to sell these prospects.in this context I analyzed various oil and gas prospects in North Dakota and Montana, did financial and lease analysis, helped prepare pro forma financial statements, reviewed his investor memorandum, and did a variety of other work including assisting on investor telephone calls. These prospective investors almost always came from Denniss websites, www.oilandgasinvesting.com or www.bakkenoilinvesting.com
I read the preplacement memorandum (PPM) of his company, New Hi-Tech Oil & Gas Discoveries, LLC, from cover-to-cover. I told Mr. Stutes that in my opinion it contained a variety of confusing representations, errors and misstatements, and lacked pro forma financial information on the oil leases he intended to acquire and on the company itself. My confusion on some of these issues was confirmed by an oil and gas accountant who I retained to assist in a review of the PPM. It became clear that Dennis was a big picture person who was primarily focused on sales of the investments, but not particularly on the details of acquiring oil and gas working interests or oil and gas production economics.
As our relationship progressed, Dennis offered me a one-half ownership in New Hi-Tech. I thought we could be a good fit because I was very detail oriented, and had done due diligence on oil and gas prospects for many years. I told Dennis I was uncomfortable with some of the representations contained in the PPM, and we agreed that any clarifications suggested by me would be reviewed and approved by John Nimmer, a Nebraska securities attorney that Dennis said he was in the process of retaining.
One of the main issues I found troubling with the PPM was that it confused working interests with limited liability company (LLC) interests. To me and to the accountant I was working with, the PPM treated these types of interests interchangeably. However, the outcome for the investor would be very different depending on whether he was investing in an LLC or receiving a working interest in wells and acreage.
Dennis told me that he was selling membership in the LLC. Sometimes he talked about offering a sweetener or a kicker being the unregistered stock of a public company that was to eventually be registered. I explained my understanding of the major difference between working interests and LLC membership interests and suggested that this point needed to be clarified in the PPM. I also told him that it probably violated the law to offer stock in a public company unless the stock was registered. I later learned that he had actually offered and sold, to at least one investor, some sort of right to purchase the public ompany stock. I do not think you can ive certain investors advantages over others unless that is disclosed in the PPM.
The ccountant informed us that the financial projections could not be accurately prepared ntil a comprehensible structure for what Dennis was selling was established, nd disclosed in the PPM. Dennis finally decided on a third option, limited partnership units. Dennis and I had telephone conversations and e-mails with Mr. Nimmer, in which he agreed to prepare a limited partnership agreement and revise the PPM. However, when I disassociated with Dennis in late March he still had not retained Mr. Nimmer and no work had been done to modify the PPM.
Another area of concern for me was that two exhibits that would be very important to investors were not included in the PPM. Dennis told me that had not yet been prepared, although they were listed in the PPM as being attachments. I was concerned because Dennis told me he had already distributed the PPM to prospective investors. The important exhibits that I thought were needed were Exhibit C (Form of Operating Agreement of the Company) and Exhibit J (Project Reports). Otherwise, investors would be investing blind.
Another area of concern for me was that when I read the PPM in February, it stated that his company New Hi-Tech was formed in December. But then at page 2 of 69 it states, During the first ten months of its
operation, the Company has invested in six oil and gas fields with producing leases and developmental projects all located in various counties in Oklahoma. These leases and projects, including present and projected wells and oil and gas production, are described in detail later in this Memorandum.
I am certain that New Hi-Tech didnt own any oil and gas fields with producingleases in Oklahoma. I suppose it was possible that one of Denniss other companies, Tar Water, owned those interests but then he should have said so in the PPM. He did tell me that Tar Water and another of his companies, Elco, were embroiled in a big lawsuit and he was trying to unload the Oklahoma wells because they were stripper wells and too expensive and problematic to operate.
In any case, I did not understand how a company could have ten months of operations if it was only formed in December and the date of the PPM was February.
Another concern was that the PPM stated at page 7 of 69 that The initial investments contemplated by the Company will be made in working interests in a horizontal well project being drilled in Roosevelt County, Montana, a well in Williams County, North Dakota, and a well in Burke County, North Dakota. Detailed descriptions of those projects are disclosed later in this Memorandum. Dennis told me that New Hi-Tech controlled the working interest in these prospects (called the Stateline prospect and the Ingerson and Hought wells). He supplied me with documents to review including leases and AFEs to drill the wells.
I discovered and reported to Dennis on certain problems with the lease for the Stateline well. He was unaware of these problems. He said he was selling interests in a well being drilled, but when I called the lease owner I learned that only the surface casing had been set. This is a technique used by operators in Montana to hold leases which may expire, while they drill other leases that are very close to expiring.in other words, it could be months or more than a year before that Stateline well was drilled.
The other problem I found with the lease was that it contained a 90-day continuous operations provision. The other leases covering this well contained longer continuous operations provisions. The problem was that unless renegotiated, this lease could expire before the others that were controlled by the operator. As a result, unless the well was drilled before this particular lease expired, Denniss company could be left holding the bag.
I also informed Dennis about certain problems with the Ingerson and Hought wells in North Dakota. He was also inaccurately representing the drilling status of those wells. When I checked with the operators I found this out.
During this process I contacted and spoke with the parties who Dennis said were selling him the interests in the Stateline, Ingerson and Hought wells. They told me that Dennis had agreed to pay them for the interests in January but never came through with the $327,600 in funds (for the Montana interests) or the approximate $175,000 for the North Dakota interests). As a result no interests in wells or leases had yet been purchased by or transferred to New Hi-Tech.
Yet Dennis was distributing a PPM and telling prospective investors that New Hi-Tech had the rights to these leases and wells. I expressed my concern to Dennis about this, and he asked me to prepare and complete a lease acquisition agreement for the Stateline acreage which I did. This enabled New Hi-Tech to represent that this particular lease and interest in a well were under contract but not acquired. However, the closing date for the acquisition was April 5 and New Hi-Tech defaulted due to non-payment. I met with the seller, one of the largest oil and gas land and leasing companies in North Dakota, who expressed concern to me that Dennis didnt understand the oil and gas business from the lease acquisition, acreage and working interest side. He said from the way he talked and the questions he asked, it was obvious that Dennis was a salesman and not an oilman. The seller said he was unwilling to deal with Dennis any longer. As a result, the interests were retained by the seller and I felt that after that Dennis should no longer be representing that he controlled these interests.
I also had discussions with the seller of the North Dakota working interests (in the Hought and Ingerson wells). They also told me that New Hi-Tech was in default. They kept saying to me they didnt understand why Dennis couldnt come up with the purchase amount, that Anyone who is real in this business has 100 grand, and that they wouldnt deal with Dennis in the future. Again, Dennis should have pulled these wells from his PPM and not represented he could sell interests in them.
When I quit Dennis in early April to the best of my knowledge, neither New Hi-Tech or any of his other companies had any leases or wells in the Bakken play under contract or purchased. However, he told me he had raised $50,000 from one investor and $20,000 from another.
Another area of concern for me was that the PPM states at page 8 of 69, Operators of the Projects, that EOG Resources, Inc, an N.Y.S.E. Company is the operator of the Roosevelt county, Montana horizontal drilling project. G3 Operating, LLC is the operator of the Hought #1-1-12H Well in Williams County, North Dakota. Cornerstone Natural Resources, LLC is the operator of the Ingerson 2-12-1H well in Burke County, North Dakota. It states at page 12 of 69, Projects in which the Company plans to Invest, that the Company has been offered working interest participation in various oil and gas fractional ownership equity interests in the following prospects and it goes on to name the North Dakota and Montana projects identified above.
As of the date of the PPM, 2/8, none of these prospects were under a written contract based on my discussions with the owners. I told Dennis that his PPM should not use the names of these operators since New Hi-Tech did not acquire rights to the working interests in these prospects and the deals had expired. I checked with the owners during the week of May 13 and both confirmed that Dennis had never acquired any interests in these properties.
At page 15 of 69 of the PPM, Distributions of Share Revenue to the Unit Holders, it stated that A simplified way to calculate an investors approximate share of oil and gas production from a given well in which the Company plans to invest is that it will equal about fifty per cent (50.0%) of the gross production cash flow, less proportionate lease operating expenses. Although each transaction will have its own applicable details, prospective investors should understand the factors set forth below.
(a) The Company will endeavor to deliver a. 77 Net Royalty Interest (NRI) lease on average. This would be the approximate percentage of the royalty remaining after providing for the Land Companies, leasing specialists and the expenses and profits paid to New Hi-Tech Oil & Gas, LLC.
(b) The majority interest holder, and/or controlling interest Operator keeps about 19-20% of the working interest.in the deals the Company will acquire, the mineral rights owners usually get 20% of the Royalty or what is considered Net Revenue Interest NRI). Consequently, to calculate the working interest, one must multiply the NRI, of. 77 times. 80 = 61.6% working interest (WI) for example.
(c) The North Dakota Tax Board takes 10% of the gross production as a royalty interest or part of the NRI. (. 90 X 61.6% WI = 55.44% working interest which is course is subject to a. 77% NRI at this point).
(d) New Hi-Tech Oil & Gas Discoveries, LLC will factor in 10% working interest which pays all salaries, and fixed expenses, plus legal, accounting and miscellaneous costs (. 90 x. 55.44% = approximately 50% gross production cash flow less L.O. E (defined below) costs per well.
(e) Lease Operating Expenses (L.O.E. S), are paid by all Overriding Royalty Interest (O.R.R.I.) Holders, or by working interest owners (WI) who all pay well expenses. L.O.E. S are usually fairly low in the first years, or a total of approximately $30,000-$45,000 per month per well. Based on reports from Operators in the Bakken Formation, the early L.O.E. S equal about 3% of each well's production.
As mentioned I had an oil and gas accountant review the PPM and run pro forma financials on the North Dakota and Montana wells and prospects that Dennis had told me he had control of. It was determined that the projected returns, based on the statements made at page 15, could not come close to being achieved.investors could not possibly receive an approximate share of oil and gas production from a given well equal about fifty per cent (50.0%) of the gross production cash flow, less proportionate lease operating expenses. That was because the fractional working interests that New Hi-Tech was seeking to acquire were approximately or somewhat less than 1% of 100% of the total working interest in each well. With a of 1% or of 1% interest, after you paid leasing costs, operating expenses, severance and production taxes, landowner royalty and overriding royalty, and the load paid to Denniss company, you would never recover enough to make close to these returns.
The PPM referred to net revenue interests as net royalty interest. I explained to Dennis that the correct term was net revenue interest not net royalty interest, and what it was.net revenue interest is the result of deducting all royalty. I never heard of a "net" royalty interest, but a landowner's royalty is what the lessor of the minerals is paid out of gross production. These two terms are opposite: one is the result of a load on the net revenue interest, and the other is a payment out of the the net revenue interest. The problem was that the net revenue interests represented in the PPM were. 77 on average, when in fact Denniss was really delivering between. 73 and. 74. This makes a big difference to the bottom line, and thus to the investor.
Another problem I discovered was that the North Dakota and Montana severance tax formulas were very different than the North Dakota Tax Board percentage described in the PPM. Also, average lease operating expenses were found to be 17% and not 10% as the PPM said.
As a result of these problems I felt that the PPM was misleading in regard to its financial projections. I told Dennis that I could not work with him unless the corrections were made to this information. At the time I quit they had not been made.
I also became concerned about Denniss representations regarding what these Bakken wells would produce. I was given responsibility for obtaining and analyzing production, lease, well and other data, the assembly of that data into plats and maps to be included in the PPM, and to work with the accountant to have the pro forma financials prepared. At the time I quit that data had not been included in the PPM.
Dennis asked the accountant to base his financial pro formas on well production rates that the accountant and I both considered to be inflated and therefore inaccurate. Dennis insisted on using the IP rate (or initial production rate) which is an initial 2 to 3 week open flow production rate. This is for flush production without a choke, which is not how you produce a well after the initial testing. When being completed, Bakken wells are overpressured by the injection of fracking fluid. During the open flow period the overpressured formation produces at a much greater rate than when the well is choked back, placed on line, and settles down into a normal production flow.
The production rates Dennis wanted to use ranged from 1,500 BOE per day to 5,000 BOE per day. The accountant, myself and Dennis had a teleconference on 3/29 in which we told him not to use these rates, but instead to use average Bakken formation multiple-stage frac production rates of between 500 and 750 BOE per day (these were the rates that had been established beginning in 2008 when enhanced multi-stage fracking came into common use). We also suggested that the generally accepted Bakken well decline curve be used. I advised that unless the PPM contained pro forma financials based on established average production data, the representations of return on investment to the investor that were being made in the PPM were misleading. They would just be close to impossible to achieve.
In numerous phone calls and e-mails I urged Dennis to have these corrections made to the PPM. I also suggested that he send a revised PPM to the prospective investors to whom he had already sent the inaccurate PPM. I was emphatic about this, in part because in some discussions Dennis expressed a high level of frustration with the legal and regulatory problems he experienced with various state securities regulators. He was irritated that he was required by his attorney to disclose multiple legal matters including cease and desist orders for securities violations issued against Dennis and his companies in various states (California, Hawaii and Oklahoma were some) and that a securities regulation matter was pending against him in Pennsylvania.
When I read the PPM I saw under Legal and Regulatory Proceedings beginning at Page 42 of 69 the nature and extent of these matters. I was concerned about the following: the Synergy SEC Investigation during 2009 and the 2008 California desist and refrain order from the further offer or sale in the State of California of securities, including but not limited to certificates of interest or participation in, or in payments out of production under, oil or gas titles or leases, in the form of units of working interests in oil projects, a 2008 cease and desist order from the Hawaii Securities Commissioner including allegations of fraudulent misrepresentation and failure to disclose material information about investments and risks of investing in the joint venture and the background of management, and a 2011 Pennsylvania order to cease and desist from the offer or sale of securities. I was very concerned over the fact that Dennis had been banned from selling any oil and gas interests in four states, but still felt that by complying and indeed over-disclosing he could avoid these issues in the future. I could not be involved with a company where proper disclosure was not occurring.
All of the foregoing is substantiated by e-mails which I have saved. I want to avoid any prospective investors being misled or harmed based on the use of my work for New Hi-Tech or other companies which Dennis controls.
In early April Dennis still had not had the PPM revised. I paused to review my entire experience with Dennis, his attitude toward investor disclosure, and his history of regulatory actions and lawsuits. I decided to disassociate withhim and have not heard from him since.
If you are not experienced in oil and gas investments, please make sure that you become educated about them before proceeding. It is well worth the money to have your attorney and/or accountant and/or someone with strong experience in this area review the proposal before you invest.
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