Oil and Gas Investments – A Primer on the Options
There are several ways to invest in the petroleum industry,
from easy retail investments like buying stocks to drilling programs for sophisticated investors. Each have a pro and con that we’ll address.
Below is a list of five basic investment vehicles:
1. Stocks in Oil Companies
2. Working Interest Partner in a Drilling Program
3. Existing working interest in a lease.
4. Stock in royalty trusts
5. Oil and gas royalties direct from mineral owners.
First – The easy, retail investment in petroleum is stocks. Simply call your broker and invest in shares of ExxonMobile, BP, XTO, or any other oil company. They often have low dividend yields of 3-6%, and a nominal growth rate. However, highlighted by the Exxon and BP oil spill, these oil stocks have a disaster risk, and a even greater political risk when congress lets loose it’s ire. The pro is that you don’t have to actively do anything, just buy the stock. The expectation by wall street is a 8% return over time.
Second – Investing as a working interest partner in a group of oil wells has great risk. You can lose your entire investment or make a killing and you don’t know which it will be when you invest. Highly volatile in its rewards, this investment can not be considered an investment but a gamble until you have enough money to invest in several drilling programs. At which time, the science of statistics will lower your variance but you will still be at risk of lawsuits, and cost overruns which you’ll be obliged to pay. The pro is that millions to billions of dollars can be invested in this market with an expectation of 8 – 12% return. This is the typical investment of choice for billion dollar companies.
Third – Buying a working interest in a currently producing oil or gas lease is less risky than partnering in a drilling program. In this case, the potential for large unexpected expenditures is greatly reduced. On the pro side, the production of the well usually stays constant and the cash flow stream from production is easier to evaluate. The big plus of this investment is a superior return, as investors are shooting for 10-20% return. On the con side, you are still at risk for regulatory compliance and lawsuits from on site accidents. However, the biggest drawback is the need for technical knowledge of oil and gas wells, decline curve analysis and other engineering know how. Further, you have to actively search for those wanting to sell working interest, or go to an auction house like www.energynet.com, or Oil and Gas Asset Clearinghouse.
Fourth – Buying stock in royalty trusts is very different than buying shares in an oil company. Royalty trusts are set up with large assets of royalty and overriding interests. Like Permian Basin Royalty Trust (PTB) or They have no business operations, only receiving cash flows from royalties. They typically are distributing 95+% of incoming cash as dividends. The pro is that there is no legal or geopolitical risk associated with an oil company. Their expected return is 7% to 9% over time. There is no effort to find these investments as they are offered on the NYSE. These investments are superior to buying oil company stocks for investors past 60 who can’t afford investments to lose value.
Fifth – Buying royalties from private owners has several pros. Namely, the return can be quite large at 12-50%. Second, buying the royalties means you are buying the minerals. So if another oil zone is discovered, you’d be entitled to yet another royalty cash flow stream. On the con side, you need to understand how to buy mineral rights. The other problem is finding private owners who want to sell. Blackbeard Data, however, provides data that has all the royalty owners in Texas and Kansas; this can be used to find royalty owners who wish to sell. Another con, is that this is requires active participation. For institutional money, the biggest con is that they can’t find enough sellers to invest billions or even hundreds of millions of dollars. Nobel royalties is a major royalty buyer, and they struggle each year to invest tens of millions of dollars. However, due to the large returns and low risk this has become the dominate and preferred investment of individual investors in the oil industry.
So look at your investing needs and pick the investments that are suitable to you.
If anyone has information or knows of a research or a study that can update this page, we’d love to see a comment from you.