Do you want to invest in oil and gas companies with low risk and high return but don’t know how? If YES, here are 7 best ways to invest in oil and gas companies.
Oil is one of the most important commodities in the world today. Crude oil and it’s byproducts are in high demand due to their multiple uses. Natural gas is used for heating and cooking. It can also be converted into diesel fuel and electricity, and it is essential in the creation of chemical fertilizers.
There are a number of ways one can invest in oil and gas. For instance, you can consider the industry a collection of companies providing products or services to consumers, as well as to other players in the oil and gas industry itself.
Advantages and Disadvantages of Oil and Gas Investment
- Diversification: if you are in need of investments to diversify your portfolio then oil and gas investment may just be the right thing for you. In times when the price of petrol rises, the economy tends to slow down, and this can make the rest of the stocks to stumble. But when oil and gas prices rise, oil and gas stocks tend to rise with them. An exposure to oil and gas stocks can help insulate your portfolio against economic slowdowns caused by oil shocks.
- Profit Potential: investing in smaller companies and limited partnerships can sometimes be quite profitable. If things go according to plan, a single oil well can be a cash cow- generating in multiple fold the amount that was invested into it for long time to come.
- Tax Advantages: investing in oil and gas companies can come with tax advantages at times. For example, the IRS allows companies to deduct for depletion – an allowance that can be likened to depreciation in rental real estate, which is a way of accounting the gradual exhaustion of mineral supplies in a given plot of land.
If you should purchase the shares of a publicly traded stock, you may not be able to see benefit since publicly traded stocks are C-corporations and don’t pass their gains and losses to shareholder tax returns. However, if you buy a membership in a limited partnership, this could be a very important consideration. Depletion could be the difference between a property that’s cash flow positive and one that loses money.
Disadvantages of Oil and Gas Investment
a. Volatility: just like a lot of investments that are out there, Oil and gas investments can be subject to wild price swings. This is even more of a problem if you are investing in a smaller company. If you get involved in exploratory drilling projects, there is a possibility that you can lose a lot of money.
In order to hedge against the total loss of you investment, it is advisable to diversify your oil and gas investments. Do not just put all your eggs in one basket. Losses of 50% or more are not unusual, and you can lose everything on any project.
b. Liquidity: even though selling shares of larger companies is quite easy and fast, you may not find such ease when trying to sell off shares of smaller companies. In some cases, you may have to redeem your interest with the company or limited partner directly.
This is sometimes the case with closely held, non-publicly traded companies and limited partnerships. When getting yourself involved in this, you have to bear in mind that your money could be tied up in the investment for quite some time, so if you need the money soon, it is not advisable to dabble into this.
c. Commissions: When you buy into a limited partnership or closely held corporation, you will typically pay a commission to a broker or intermediary. These commissions tend to be much larger than standard stockbroker commissions, and can exceed 20% for very illiquid companies. Any money that goes to a broker is money that doesn’t get put to work for you.
d. Complexity: investment in closely held companies, oil wells, and other ultra-micro-cap oil and gas projects can be quite tough for some people because of the complex and convoluted nature of the industry. There are special tax rules that govern oil, gas, and mineral investments, and there are rules specific to limited partnerships that may affect you – especially as you file taxes or account for shares when you sell them.
You should however note that that even though a lot of limited partnership opportunities are legitimate, there are still a lot of scammers in the industry. You should beware of anyone of tell you that an investment is foolproof and that huge returns are guaranteed.
And never buy into a limited partnership or purchase a share of stock over the phone. At the very least, get a prospectus and do your own due diligence. You should get your own independent financial advisors who have experience in the industry and do not have a vested interest in whether you invest.
7 Best Ways to Invest in Oil & Gas Companies
You can approach oil and gas investing in so many different ways. For instance, you can regard the industry as a collection of companies providing products and services or customers as well as to other clients in the oil and gas industry itself.
You can also approach the industry as a commodity, and seek to profit from changes in the prices of crude oil, gasoline, diesel, and other products.
i. Mutual Funds or ETFs: For a casual investor, an oil commodity exchange-traded fund or mutual fund is the simplest and least-scary way to start investing in oil. You can buy shares in a number of oil and gas-focused mutual funds or ETFs. This will help you to gain substantial exposure to the commodity without taking direct risk in commodity spot prices and without tying too much of your fortune to the prospects of any one company.
ii. Large Cap Stock or ADRs: These are two methods to gain exposure to the oil and gas markets, both via publicly traded companies. You can buy stock in other companies such as British Petroleum, PetroChina, Chevron, ConocoPhilips, Marathon Oil, Royal Dutch Shell, Gazprom, the Anadarko Petroleum Corporation, and many others. These companies are involved in the exploration of crude oil and you can buy direct exposure to them simply by buying shares or ADRs (American Depositary Receipts) through your broker.
iii. Futures Contracts: another way to invest in oil and gas companies is to purchase derivatives such as oil and gasoline futures contracts; these, however, can be risky, since futures contracts can and do frequently expire without actually having any worth.
iv. Small or Micro-cap Stock and Limited Partnerships: If you would like to take on a more direct equity position in a smaller company, you can consider making a play further down the oil and gas industry “food chain” into a small or micro-cap stock , or even a limited partnership that focuses on oil and gas.
This field is more specialized and in the event that the business is not publicly traded, you will need to go through the services of a broker who specializes in this industry so as to get access. Or if you have a significant amount you can invest, you can deal with the company’s management directly for a private placement opportunity.
v. Buy oil stocks and energy stocks: the price of crude oil in the markets tend to have a direct effect on the worth of Halliburton (HAL), ExxonMobil (XOM) and BP (BP) shares, and investing in well-known oil stocks will let you know if the oil industry and related energy industries are the right fit for you. Carry out your research on how much debt oil and energy companies are carrying, how much profit they’re generating and how much they’re paying investors in dividends.
vi. Buy oil futures: this investment strategy is one of the riskiest ways of investing in oil and gas commodities and companies. However, it is still a lot better than maintaining hangars filled with oil barrels.
Oil commodity futures are very volatile and investing in them requires putting in huge sums of money upfront. Investors who aren’t accustomed to doing in-depth research and taking substantial losses should approach with caution.
If you’re ready, however, oil futures can be found on the New York Mercantile Exchange, among other commodities exchanges. If you buy into an oil futures contract and the price of that oil goes up before the contract runs out, those oil futures can be a lucrative investment. But that is where the risk in oil investing lies.
People who usually invest in oil futures such as heating oil contractors, fuel oil suppliers, even airlines tend to be quite knowledgeable about the costs of oil throughout the year and they have a good idea of when it is best to buy. The average investor may not have similar familiarity with oil commodity pricing and patterns. Only approach this particular oil investment if you’ve done significant research or have an adviser who’s familiar with oil futures.
4 Types of Oil and Gas Investments
Basically, there are 4 types of oil and gas investment. They are discussed below;
- Exploration: these companies buy or lease land and also invest in the drilling of crude oil. In the event that they should find oil, the investment can pay over 10 or even more of the amount invested. If not, they may lose nearly everything they invested in that particular project. Investing in this form of business is best suited for people who have a high tolerance for risks.
- Developing: these projects involve drilling near proven areas with the hope to unlock further value. These are somewhat less speculative, but there are never any guarantees that efforts on any one plot of land will bear fruit.
- Income: these projects involve the acquisition of lots of land, either through lease or purchase, over proven oil and gas reserves, and seek to create a steady stream of income over and above expenses. This method is generally considered to be very safe when compared to other strategies on this list. In addition it is more of an income play than a speculative play. The risk is that the oil or natural gas will run out faster than expected.
This investment will be well suited for people who are in need of passive income stream, but are willing to take on additional risks than those investing in other traditional income generators, like investment grade bonds and annuities.
4. Services and Support: these companies are involved with providing a nearly unlimited menu of supporting services to the oil and gas industry such as transportation, shipping and logistics companies, pipeline companies, construction and rigging companies, drilling and refining hardware and equipment manufacturers, refiners, and many others.
Investing in any of this sort of company is quite similar with investing in any other company involved in B2B services, logistics, technology, and the like. Some of these investments don’t rely on increasing fuel prices to be profitable. For instance, pipelines make money by charging a fee per barrel transported. They’ll make roughly the same amount regardless of whether fuel prices rise or fall, as long as demand remains consistent.
In conclusion, oil and gas investment can be quite volatile. Whenever you go into these investments, you should know that there are risks involved. So if you are a natural entrepreneur who can afford to lose substantially on any one venture, then you can go for this.
If you cannot withstand the risks, you can go for more conventional plays: shares in big companies like ExxonMobil and Halliburton, for example, or mutual funds that focus on oil and gas.
In addition, you should take note of liquidity. If there is any chance at all you will need to pull your money out in a hurry, the limited partnership route is not for you. These investments can be lucrative, but they work best for those who are able to lock up their funds for years at a stretch.