[Posted on February 17th, 2015 by Michael L. F. Slavin]
Although oil and gas investments share many traits with general stock market speculation, the differences are large enough to warrant treating them distinctly. Savvy investors, in fact, think of their oil and gas holdings as different investment vehicles altogether – especially given the tax-free status of 15% of the income you derive from these holdings. When investing in any kind of stock, it’s important to realize that the more you know about the company, the less it’s like gambling; obviously, the converse rings true as well. As such, it’s important to know how to invest in oil by keeping to best general practices, while realizing the distinct differences and positioning yourself to capitalize on the unique benefits of oil wells.
Know Your Prospective Company
This isn’t any different than knowing the track record of a vendor in any industry; in stocks, however, it’s more important than anywhere else. If you want to know how to invest in oil properly, you’ll need to use technical or fundamental analysis to gauge a stock, then the better you’re aware of company details, the more accurate your analysis and surer your investment. Investigate the publicly-available documents for financial details, as well as projected earnings. Because oil wells have so many auxiliary industries – equipment, logistics, etc – you may even decide to invest in one of these verticals.
Is There More than Meets the Eye?
With oil and gas, there’s often more to see than what is on the surface. Present production is a great incentive, of course, but proven reserves are just as valuable – and potentially, much more so.
For example, what’s the production ratio when compared to these reserves? Is the company actually able to extract efficiently, using the latest technology available to ultimately minimize costs? Some of this advanced tech consists of three-dimensional seismic imaging to increase the industry-standard 80% oil drilling recovery success rate. Cost-benefit matters just as much; understand your chosen company’s oil well-selection process to minimize their – and your – overall cost.
Understand the Location of the Well
Historically, oil wells that are found close to existing wells possess a much greater chance of being profitable. It doesn’t matter if the existing well is nearing depletion, already dead, or still going strong – the reservoirs aren’t connected underground. This is termed ‘developmental drilling,’ and it proves profitable greater than 90% of the time. Compare this reality to speculators that start drilling far from anywhere; the chances of discovering oil are remote, and in the range of 4%.
Consider Multiple Investment Streams
Much like diversification of your stock portfolio, the oil and gas industry is robust enough to have several different properties. You can consider investing in the exploratory aspect, which has the greatest potential rate of return but also the most risk. There’s also a long-term income option associated with proven reserves. Investing in this aspect provides you with an income stream similar to municipal bonds – although not quite as secure; the amount of money is usually considerably greater.
Investing in developing oil wells was mentioned above, and is the traditional option for beginning investors in the oil industry. They are speculative if the drilling operation is far from existing wells; less so if nearer. Lastly, the services and support option is the most independent of the fortunes of a particular well, and tends to be steadier – though the rewards are generally less.