Making the decision to invest your money in someone or something else is a huge step. It takes a considerable amount of research, preparation, and commitment. Do not throw your money around before understanding your goals and how they fit within your comfort zone; the market you are investing in; and the types of investments that will work best for you. Investing is also an incredibly personal journey. While you can rely on advisors for information, tips, and even guidance, you should never let someone else make big decisions regarding your money for you. Any investments made with your money should only be done if you fully understand and are comfortable with them.
The First Step
Before you can start investing and (hopefully!) profiting, you will need to do your research and determine where you want to invest your money. Choosing a market or industry in which to invest your money will depend on your interests, your knowledge, your risk tolerance, and your budget. Now more than ever, new and experienced investors alike are choosing to sink their money into the oil and gas industry.
Why Invest in Oil?
There are a multitude of reasons why investors today are choosing to invest in the oil and gas industry. As with any industry, it has it’s pros and it’s cons, but most feel the highs outweigh the lows. Not only does investing in energy typically offer a strong ROI (return on investment), it can often be utilized as a great source of passive income. This, along with its low correlation to the fluctuations of stocks and bonds, make it an attractive market for investing. To help you achieve the best outcome from your decision to invest in the oil and gas industry, we’ve done our research and collected a few important pieces of information that you should be familiar with before taking the next step. Read below to learn more about the 5 things you need to know about investing in oil and gas.
Know the Different Ways of Investing
Before jumping into investing in oil and gas, you are going to want to know and understand the different ways in which you can invest.
- Purchasing Oil Company Stock
Big oil companies, such as Exxon-Mobile, Royal Dutch Shell, or Conoco Phillips (to name a few) have consistently high net incomes, meaning their earnings per share are also comfortably high. This makes purchasing oil company stock a good move to make for novice investors, as stocks in these large companies are relatively low risk and easy to obtain.
- Buying Into A Limited Partnership
Buying into an LP gives you a more direct equity position. Larger companies do not offer this option, as they are organized as corporations, rather than publically traded partnerships. This means you would be buying into a smaller, up-and-coming company, which can have its benefits. Because LP’s are smaller, less established companies, they do carry a slightly higher risk with them than big company stocks do.
- Investing in Mutual Funds
The third major way to invest in the oil and gas industry is through Exchange Trade Funds, which are mutual funds that are sold on the stock exchange. Mutual funds are a great way to diversify your portfolio. They provide investors with a range of investment types and keep investors funds spread amongst a number of companies, versus bundling all of their money into one company. This diversification helps keep the risk of mutual funds on the lower end of the scale.
Know the Different Types of Investments
Exploration companies are one of the riskiest options for oil investing. These companies invest their money into drilling for oil. Rather obviously, they are companies that are “exploring” in hopes of striking new oil reserves. When they are successful, the investment pays off in a huge way. However, when a drilling project is met with no oil, the loss potential is great.
Developing companies drill for oil near pre-existing wells and proven reserves. This makes them less risky than exploration companies because they are drilling where oil is known to be. The chance of them hitting oil is significantly higher, but they are still not without risk. There are no guarantees when it comes to drilling.
Companies dealing with income are in the business of purchasing pieces of land that are over existing oil deposits. These plots of land are turned into operating wells that bring in steady income. This is the lowest risk option for investors looking to invest in drilling operations, as it is the only option where the presence of oil is guaranteed. The only risks comes from the chance of the oil reserve depleting quicker than anticipated.
- Services and Support
This category includes all of the companies that offer their particular services to the oil and gas industry. Transportation, equipment manufacturing, construction, pipelining, and logistics companies are just a few of the many service providers involved in oil and gas. These companies are involved in a less direct way than the drilling and extracting companies, making them less risky, as they typically have operations in other industries as well, diversifying themselves.
Consider the Advantages of Oil & Gas Investments
This piece of advice, along with the next, ring true not only for investing in oil and gas, but any investment you may make. Always, always, consider both the advantages and the disadvantages of the investment. In terms of the oil and gas industry, there are three obvious advantages.
- Profit Margins
When an oil investment pays off, it usually pays off tenfold. If a drilling company hits an oil reserve, you can guarantee you will make your investment back and more, and not only will you reap the initial benefits, it will continue to pay off, potentially for years, as the well continues to bring in revenue.
Keeping a portfolio inclusive of investments both in and out of the oil and gas industry will help balance your losses if the economy slows down. This is because the economy and the price of oil and gas are indirectly proportional. When the price of oil skyrockets, the economy slows down, and vice versa. Having investments on both sides will help balance your portfolio, lessening the impact of either a slow economy or a drop in the price of oil, and softening your losses.
- Tax Advantages
Surprisingly, there are a few ways in which you can benefit from tax advantages through your oil and gas investments, specifically if you have bought into a limited partnership. Tax sheltered earnings, resource depletion allowances, and intangible drilling costs are the three major tax advantages available. Tax sheltered earnings limit the amount of investment income that you will pay taxes on; resource depletion allowances aim to control your cash flow when the stocks suffer due to the depletion of oil in the reserve you’ve invested in; and intangible drilling costs allow investors to write off their first year of income as an expense.
Consider the Disadvantages of Oil & Gas Investments
The market price of oil is almost constantly fluctuating. Factors that affect these market prices are well out of the investors’ hands, leaving you powerless against these fluctuations. On top of these fluctuations, explorative drilling projects often face 100% losses. To avoid losing all of your investment, be sure to diversify through a variety of projects to balance out the risk.
- LP Commissions
It is not likely that you will be able to buy into a limited partnership without dealing through a broker or some other intermediary. These intermediaries always come with a commission fee that far exceeds the fees charged by typical stockbrokers. These commissions will increase in percentage as for companies that pose higher risk and lower liquidity.
In terms of liquidity every company is different. Stocks from large, well-known, successful companies will typically be easily liquidated, as you should be able to find buyers rather quickly. It may not be so easy to find buyers for smaller profile companies, so do not invest in them unless you are willing to risk having your money tied up.
As with any industry, there are dishonest people who will try to sell you illegitimate products in order to take your money. If an investment opportunity seems too good to be true, it most likely is. Be wary of anyone claiming an investment is a “sure thing” or a “no fail”. Investing comes with no guarantees, and anyone claiming otherwise has probably got something to hide. Do your research, be cognizant of who you are dealing with, and never make purchase over the phone.
Understand the Price-Driving Influences
As we mentioned before, the market price of oil is highly volatile. These fluctuations in the price of oil will have direct benefits or consequences on your investments. In order to comfortably invest in oil, you should have an understanding of the price-driving influences. There are four factors that impact the market price of oil: supply, demand, quality, and speculation. For a more in depth look at what these factors are and how they affect the price of oil, read more here.
The Next Step
Once you have an understanding of the oil and gas industry, the market trends, the types of investments available, and both the advantages and disadvantages of those investments, you should be ready to begin your investing journey. As with any investment opportunities, prepare by outlining your goals and researching what investments can best help you achieve them; be cognizant of who you are dealing with; and most of all, don’t forget to ensure that you are aware of, and are comfortable, with the risks you are taking. References