Investing in Oil & gas
When it comes to investing, the age-old advice still rings true: Diversify.
One of the ways to do that is by introducing yourself to the commodities market. The world is still running on oil and gas and will for another generation or so at least.
Typically, when the economy is buzzing with productivity and growth, oil prices are down. In these scenarios, your other investments might be looking great while those oil stocks, futures, or etfs might not be doing so well.
However, as we all know the market if it is anything is predictably unpredictable. In other words, the market will stumble and oil prices will predictably rise.
Those oil stocks, futures, or etfs are then doing you quite well. Of course, it is not that simple, and there is a great deal of timing, luck, and common sense involved in all things investing.
Bottom line is exposure to oil and gas can be a solid part of an investment portfolio.
Depending on what kind of investor you are, oil and gas can offer different levels of risk and return. If you are just looking to buy and hold then stock in an oil company might be for you.
In addition, a lot of large cap companies in the industry offer dividends for shareholders. Looking to get a wide exposure that seeks to track the market?
ETFs are a solid choice for the investor who wants his or her portfolio to have some equity in oil and gas without too much risk. For the heady investors out there, oil futures have long been an avenue in the commodities- high-risk contracts that seek to essentially bet on the future price of oil (or any commodity).
This is best for those with a high degree of knowledge and expertise. And finally, my personal favorite: a stake in an actual oil or gas well.
Again, this is mostly for the learned investor and for those with a tolerance for risk. The payouts can be large but a total loss is also certainly possible.
My grandfather’s family owned a Standard Oil filling station in the 1930s. As an employee, in addition to his wages, he was given shares in Standard Oil. After WWII, he returned to the states and the family sold the station and he began a new career as a telephone lineman which he would do until his retirement in 1980.
During all that time he held onto his Standard Oil stock and always reinvested the dividends. The stock split many times over the course of his life and with the merger of Exxon and Mobil in 1999, he ended up owning 80,000 shares of ExxonMobil.
Now, if that is the kind of buy-and-hold investor you are, then oil and gas stock might be for you. Granted, there is probably not that kind of long-term growth left for a single oil stock but the general idea and benefits are still possible: relative stability and potential for dividend payouts or dividend reinvestment and growth.
Exchange Traded Funds are a bit like mutual funds – they are an investment vehicle that samples the market without loading the risk into one company. ETFs are usually low-fee investments or sometimes no fee if you go with a robo-advisor. There are a myriad of ETF options, but they usually fall into two categories:
- Oil Futures
- Oil Stocks – domestic, foreign, or global (large cap, small cap)
ETFs are the easiest investment option and the safest bet for the average person looking to add a little more dimension to their portfolio.
Crude oil futures are contracts where the buyer agrees to a preset price per ‘lot’ of oil. A ‘lot’ is typically 1,000 barrels.
There is a future date when the contract is up and the buyer either agrees to the actual oil delivery (very rare), or more likely a cash payout or reinvestment, depending on the current price of oil.
That is the investment: buy futures when oil is low and hope that the timing of the contract corresponds with a rise in price. Obviously, it takes a lot of money to purchase a ‘lot’ so most investors use ETFs to gain exposure to oil futures as the buy-in is astronomically lower.
Crude Oil futures are commonly exchange-traded on the New York Mercantile Exchange (NYMEX) and International Continental Exchange (ICE).
Invest in an Oil or Gas Well
This has the most potential for return and loss.
Thanks to new crowd-funding platforms and the JOBS Act of 2012, everyday people can get in on securities that were once relegated to strict investor accreditation.
Direct investment through drilling companies still has a narrow investor profile but places like energyfunders and crudefunders, make it possible to own part of a working oil or gas well for as little as $1,000.
The risk here is that the well turns up dry, or it produces far less than projected.
In this scenario, investors are plain out of luck. The benefits of a direct investment are in a well that produces as predicted or even more than predicted. Oil and gas wells can produce for 10 or 20 years, or even longer.
This can be a long-term revenue stream as profits from the well are generally doled out monthly or quarterly. In addition, there is a large tax deduction similar to that of real-estate, called a depletion allowance.
From day 1 of an active well, production will begin to decline – the flow of gas or oil will slow as the pressure in the underground formation is released and the resource is depleted.
There is a 15% exclusion from taxable income from this asset which can be a significant amount over the life of the well and your investment.