The Smart Investor’s Guide to Investing in Oil Wells and Gas

August 31, 20237 min read
The Smart Investor’s Guide to Investing in Oil Wells and Gas
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Key Takeaways

  • There are federal tax benefits associated with oil well investments, including deductible tangible and intangible drilling costs.
  • Investors can go through publicly traded companies such as ExxonMobile, ConocoPhillips, and Phillips 66 to gain exposure to oil, most of them involved in oil exploration.
  • Investing in oil and gas private placements requires the investor to be accredited,  meaning they are allowed to participate in investments not registered with the U.S. Securities and Exchange Commission.

Last year, the global oil and gas exploration and production industry rose a whopping 71.8%, with further increases expected. For those interested in investing in oil wells and gas, the following is a comprehensive guide to navigating the high-reward but complex landscape.  

What is Oil Well Investment?

Petroleum – crude oil – is a major commodity in the U.S. and globally. It is extracted from the ground with large oil rigs then refined to produce gasoline and other products such as bike tires, perfumes, deodorant, paint, mops, golf bags, and hair coloring. 

The world’s top 10 oil-consuming countries use more than 50 million barrels of oil daily, and projections are that, by 2035, world energy consumption will grow by 49%, with most energy supplied by oil and gas.

All this means ample, and possibly lucrative, opportunities for investors in oil. And there are multiple ways to take positions in the market.

The Upsides

There are advantages to investing in oil wells, including:

  • Passive income. There is the possibility for strong, and consistent secondary income.
  • Tax deductions. To spur investment participation in oil, the federal government offers a number of deductions and tax relaxation benefits.
  • Not subject to market fluctuations. Investors need not fret about fluctuating stock prices since oil production is not linked to the stock market.
  • Technological improvements. Advances in oil and gas technology have resulted in significantly heightened access to crude oil, which have decreased risks.
  • Hedge against inflation. Investments in oil are not as susceptible to inflation and other economic downturns. 

Investment Avenues

There are various options for investing in oil wells:

  • Direct investment in an oil and gas project. Also known as direct participation, direct investment has two categories, including working interest ownership, which allows investors to own a portion of the oil well. Here, investors have more obligation than in a limited partnership, which is the second category.  With limited partnership ownership, working capital is used to further empower general partners.
  • Investing in oil and gas mutual funds or ETFs. Investors can buy oil shares from mutual funds and ETFs. The benefit here is no direct risk in spot prices. ETFs provide access to a number of different assets simultaneously while diversifying one’s portfolio. They consist of company stocks, derivative contracts, futures that track oil prices. To get started, research oil-price trajectories, looking closely at how ETFs react to changing market conditions.
  • Investing in oil and gas companies through the stock market. Investors can go through publicly traded companies such as ExxonMobile, ConocoPhillips, and Phillips 66 to gain exposure to oil, most of them involved in oil exploration. In addition to ADRs and large-cap stocks, there are micro-cap stock opportunities. Look at a company’s return on assets, operating cash flow, balance sheet liquidity, and their earnings growth on the income statement
  • There are also oil futures, which are derivative securities that enable the shareholder to purchase crude oil at an established price.

Do Your Homework

Before positioning their capital, it is key for investors to first conduct research. That should include:

  • Researching the company or fund in which one is investing. Look into the company or fund of interest and make certain it offers promising investment opportunities. 
  • Understanding the potential risks involved with oil well investments. Those risks include commodity price volatility, the possibility of an accident such as an oil spill during production, high liquidity, dividend cuts, and risks associated with machines and equipment used in exploration.
  • Evaluating market conditions for oil prices and production costs. Global supply and demand drives crude oil prices. Thus, economic growth is a key factor impacting crude oil demand. And when gas prices rise, oil prices and investments increase as well.

Tax Perks

There are tax benefits associated with oil well investments.

  • Deductible tangible and intangible drilling costs (IDCs) on federal taxes. The federal government permits oil investors to deduct intangible drilling costs – grease, chemicals, and labor, for example — in the year the investment is made. During the first year, such deductions can result in up to 80% of expenses deducted. Tangible drilling costs, such as for equipment, are usually amortized and depreciated over five to seven years.
  • Other tax benefits. To support U.S. investors in participating in oil and gas opportunities, Uncle Sam also allows depletion allowances, and 15% of the property’s gross income is untaxed.

Accredited Investor Requirement for Investing Directly in an Oil Well Project

Investing in oil and gas private placements requires the investor to be accredited, meaning they are allowed to participate in investments not registered with the U.S. Securities and Exchange Commission. To qualify, one must have a net worth of at least $1 million, excluding their residence’s monetary value, or more than $200,000 in earned income in the previous two years, with the expectation of the same earnings.

Alternatives to Oil Well Investments

Increasingly, investors are turning to alternative assets to lower portfolio volatility since such assets have low correlation to public markets. Adding them to one’s holdings can also potentially add steady passive income and protect against inflation. In every economic downturn of the last 15 years, private markets have outperformed stocks.

Going through a platform such as Yieldstreet makes such investments particularly accessible, what with its low minimums and rigorous vetting process. While no investment is risk free, all opportunities are subject to robust due diligence before it makes the leading platform.

Nearly $4 billion has been invested to date, with returns exceeding $2.3 billion. Yieldstreet also offers the broadest selection of asset classes available, including opportunities in art, real estate, transportation, private credit, structured notes, transportation, crypto and more.

Another primary benefit of oil wells and other alternative investments is diversification – spreading investments around so that exposure to any single asset type is limited. Diversifying one’s portfolio is an essential pillar of long-term investment success.

Portfolio Diversification and Alternative Investments

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary 

Investing in oil and gas can be lucrative, but there is an equal amount of risk, which the investor should understand. The market can also be unwieldy to navigate.

There are other alternative investments that come pre-vetted, so that due diligence is not as much of an investor issue, and that can diversify one’s portfolio.

Disclaimer: All securities involve risk and may result in significant losses. Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information. Diversification does not ensure a profit or protect against a loss in a declining market.

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