When things are good no one really cares what goes on. It’s when things turn south that other risks such as questionable related-party transactions are brought to light and compound the problems. While low natural gas prices exposed the debt issues at SandRidge Energy Inc. (NYSE:SD) and Chesapeake Energy Corporation (NYSE:CHK), the media attention surrounding the related-party transactions has kept the lid on the shares of both companies. It can take the market a long time to get past these practices after they’ve been questioned.
In closing, I want to draw your attention to one last related-party relationship that you should watch. In this case its not repeated transaction with a founder but with another company. As an example, liquids-focused driller Gulfport Energy has a very close relationship with Wexford Capital and if you read through Gulfport’s last two annual reports you’ll see a lot of activity between the two. In fact, virtually every deal Gulfport has been involved in was with an affiliate of Wexford. In one example, the company’s 2012 annual report states:
We, through our wholly owned subsidiary Grizzly Holdings, own a 24.9% interest in Grizzly. The remaining interest in Grizzly is owned by Grizzly Oils Sands, an entity owned by certain investment funds managed by Wexford Capital LP, or Wexford. An affiliate of Wexford owned approximately 13.3% of our outstanding common stock as of December 5, 2011, and approximately 9.5% as of March 13, 2012, which ownership was reduced to less than 1% as of September 28, 2012.
You’ll see similar disclosures in almost every transaction Gulfport completes. This was most recently seen when Gulfport acquired 22,000 acres in the Utica from an affiliate of Wexford for $220 million, or $10,000 an acre. While the Utica still appears to be a great play and Gulfport’s acreage is in the sweet spot, it paid a lot of money for those acres. This is a story that could go either way, if the Utica turns out to be as good as or better than Gulfport expects then the relationship with Wexford will have turned out to be a tremendous asset. However, if Gulfport starts to perform poorly, investors could begin to question these deals.
That’s why as an investor you have a tough choice to make. You can see these related-party relationships as something to avoid as it adds another layer of risk. On the other hand, these relationships could turn out to be very beneficial as the related parties tend to have a significant vested interest in the company’s success. That’s why I’d encourage you to dig a bit deeper into an independent oil and gas company before you buy to make sure you are comfortable with any related-party relationships before you’ve invested your hard-earned money.
The article 1 Hidden Risk Energy Investors Must Watch Very Closely originally appeared on Fool.com and is written by Matt DiLallo.
Motley Fool contributor Matt DiLallo has no position in any stocks mentioned. The Motley Fool has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy.
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