As all investors know, when Warren Buffett says that something is a big deal…then it definitely is a big deal!
Revolutionary advancements in horizontal drilling a.k.a the “fracking” process you’ve heard so much about have allowed the United States to rocket past Saudi Arabia and Russia to the top of the world’s energy producer list.
In the coming pages, you will learn everything you need to know about how to invest in oil and gas. Everything from theory to practice will be covered, so make sure that you read carefully, while paying special attention to the videos and images for a clearer understanding of the overall picture.
But before we get started, here is a fantastic video on the history of the oil and gas industry. It will help you understand the overall oil and gas investing environment.
According to David L. Greene…
The basic amenities of living are clothing, food and shelter. However, with the advancement in industries and machinery, petroleum and its products are extremely necessary for human existence as well. If we do not get an adequate supply of petroleum products, we might as well go back to the Stone Ages.
Apart from diesel, petrol and gas, petroleum provides raw materials for various pharmaceutical products, chemicals and fertilizers. Petroleum has been used for over 5000 years in an unrefined form. Over 60% of human energy requirements are met by oil and gas. The remaining 40 percent energy requirements are fulfilled by other sources such as sun, wind, coal and water.
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In addition to this, the oil and gas industry has been a key influence on the global economy. Oil in its natural form can be found in the earth’s crust. It has to be extracted to manufacture various products. In order to carry out the extraction process, holes of different sizes from five to fifty inches are dug with the help of a drilling rig to take out crude oil with pressure techniques.
This extracted oil is then transferred to refineries for advanced processing. The oil wells are disposed of once productivity goes down. Hydraulic fracking techniques are employed to increase the extraction rate. However, this technique has been banned in a few countries and is under intense scrutiny in the US because of its potentially bad impact on the environment if it is not handled with safety and care.
It is important to know the origin of petroleum as it has become vital for the survival of mankind. Petroleum is formed from the remains of dead organisms and animals. It takes a long time for these organisms to get converted into petroleum. After this crude oil is formed, it gets converted to different forms.
Petrol is required for automobiles which keeps our life on the ‘move’. We cannot imagine living even one day without petrol, gas or diesel. However, due to advancements in technology and oil industry, its usage has become more that its availability. Governments of most countries have been trying to lay down various policies with other countries to supply enough petrol.
It has been observed that due to the increased demand, many countries are facing challenges to meet these requirements. These countries have employed techniques to save energy or increase alternative sources so that the next generation to come does not face scarcity.
Oil and Gas Investing: Potential Risks
Carmen Linehan adds that, “anyone who wants to diversify his or her portfolio should consider investing in oil and gas. When investing in you should not only be aware of the possible return on your investment, but also the risks. All investors should be informed. For many investors the risks are worth taking.
An investor can invest in by investing in commodities, stocks, gas or oil properties, and wells. Each has varying potential for return and varying risks.
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Some investment risks can be controlled or managed, while other risks cannot be controlled like political (war, elections, etc.) events and environmental conditions (earthquakes, floods, etc.). Investment risks to be aware of when considering investments:
• No oil or gas is produced
• Not enough oil or gas is produced to make a profit
• The well is depleted sooner than anticipated
• Oil or gas company files bankruptcy
• Third party theft
• Disputes over surface damage
• Litigation and fines that reduce profits
• Owner misrepresentation
• Higher operation costs higher than estimated
When investing, you should always follow the rule of thumb…only invest in what you can afford to loose. Though there are high returns possible when investing in oil and gas, there is also a chance of loss.”
In addition, oil and gas stand to change America’s economy and job markets in ways never before fathomed, including the age-old political selling point of “energy independence”.
What makes today’s atmosphere so unique, however, is that energy independence actually may be on the horizon for America and to borrow an old adage “the world as we know it, will never be the same again.”
Just look at the evidence…
The most important information about the changing landscape of oil and gas in America, may lie in this simple, but telling image:
Sadly, the Keystone XL issue is very much political and even though everyone with a cursory understanding of markets and economics knows that this its build-out would be a huge boon to America’s economy and job market, the project still hasn’t been approved.
Oil and Gas Investment Opportunities
Suzanne Bender believes that, investing in oil and gas opportunities being offered by the best oil and gas companies is a sure way to beat the stock market these days. It has to be done correctly and only with the very best companies.
Companies that you choose to invest in must be successful and knowledgeable of the risks that go along with drilling for oil and gas.
They must know how to handle and manage these risks, have best technology, hire the best contractors and drilling companies, and be able to perform well in all market conditions. By investing with consistently well performing companies, you minimize your risk.
There are many areas of concern when investing with oil and gas companies. Beware of quick estimates of cash flow distributions from newly drilled wells. At least 90 days are needed to begin to receive income from new development activities. New wells require fine-tuning and purchase contracts need to be negotiated, especially when drilling deep onshore or offshore wells that have large commercial reserves. The process usually takes between 6-12 months for cash flow to really begin. Big companies want to establish long-term cash flow and not shallow wells with short-lived production, something to keep in mind when considering investments.
Successful companies do not entertain wells with rapidly depleting reservoirs, they want to maintain revenue stream for a longer period of time.
Another area of concern is to be sure that the tax write-offs are legitimate and properly listed in their yearly K- reports. These reports are prepared by the development companies and sent to the IRS yearly.
That way, you can get all of the tax benefits available from the investment to lower your taxable income from all the sources.
Oil Investing: Key Terms To Know
There is much to learn about oil and gas, the education can be ongoing for even the greatest expert. There are, however, three key terms to understand with regards to how and why oil and gas markets move.
Demand – Before investing it is necessary to know which regions and countries have a high rate of demand for energy. All modern industrial economies need oil, but those with more factories, manufacturing and larger populations will demand more of it. There is never really a lack of demand for oil, as you’ll occasionally hear the media tell it. There is just the fluctuation between supply and demand that can sway prices.
Supply – For a very long time, supply was a problem in the energy sector. OPEC notoriously “blackmailed” the world with their price fixing in the 1970’s. With advancements in horizontal drilling, however, extracting more oil and gas from the earth has become a lot easier and notions like “disappearing supply” and “Peak Oil” have pretty much been muted.
Purity – One of the key problems facing oil and gas markets is the lack of high-quality material, or the lack of what is known as “sweet” crude. Sweet crude oil is a type of petroleum. The New York Mercantile Exchange designates petroleum with less than 0.42% sulfur as “sweet”.
“Light sweet crude oil” is the most sought-after version of crude oil as it contains a disproportionately large fraction that is directly processed (fractionation) into gasoline (naphtha), kerosene, and high-quality diesel (gas oil).
Petroleum containing higher levels of sulfur is called sour crude oil. Sweet crude oil contains small amounts of hydrogen sulfide and carbon dioxide. High-quality, low-sulfur crude oil is commonly used for processing into gasoline and is in high demand, particularly in industrialized nations.
The term “sweet” originates from the fact that a low level of sulfur provides the oil with a mildly sweet taste and pleasant smell. Nineteenth century prospectors would taste and smell small quantities of oil to determine its quality.
For instance, Brent Crude is not as light as WTI, (West Texas Intermediate) considered the benchmark for all crudes. When compared to Brent and WTI, the OPEC Reference Basket benchmark is a heavier blend and the same can be said of the Venezuelan oil found at Citgo stations throughout the U.S.
Lighter versions of crude oils are priced higher in comparison to crude oils classified as heavy.
Oil and Gas Investment Types
Veteran currency trader Samo Janezic clarifies further:
Oil and gas investments are generally considered safe investments, as they are commodities that will be used for a number of years in the United States. While the prices can fluctuate greatly, large amounts of money can be made in oil-gas investments if you do some research and buy or sell at the right time.
There are several ways that you can make investments with oil and gas, through company stock purchase, mutual funds that invest in the energy sector or commodities trading.
You need to do research on when is a good time to buy and sell oil and gas investments. Right now, prices are down, so we are nearing the bottom, because of the state of the economy. As the economy comes back, oil and gas investments will go up in value.
There are many companies that drill for oil or gas as speculative ventures. There are also established companies that have been around for years. Some of these companies stop operations when the cost to produce outweighs the consumption and prices they can sell for. Unlike other industries, large oil-gas investments companies are very astute at monitoring cost of production and profit margins.
The mutual funds that invest in the energy sector typically invest in large and independent oil companies. They also invest in drilling, which can be more speculative in nature, but give a larger return if oil or gas is discovered.
There are two types of drilling-exploratory and developmental drilling. The first is exploring to find oil or gas, while the latter is to bring up already discovered oil and gas deposits. Typically, developmental drilling uses wells that already exist and monitor production at a profitable margin.
Oil and Gas investments can involve in investment in a company’s stock, where you receive royalties, and share in the operations of the company. Many oil and gas companies discover oil or gas deposits and develop those finds at a later time, while retaining rights or selling when profitable.
Much of the speculative nature of oil-gas investments involves drilling to find deposits that will be profitable to develop and money is sometimes spent where they are unsure as to the size of the oil or gas pocket.
Since discovering new sources of oil and gas is part of the nature of the business for the future, they can incur expenses that seem large when they are looking for new sources and initial capital requirements to develop the oil-gas investments that they locate.
Ways to Invest in Oil and Gas
McCartney Taylor is the President of Blackbeard Data Services. He is involved daily with helping investors find oil and gas royalties to buy. Here’s his take on the best ways to play the oil and gas markets:
There are several ways to invest in the petroleum industry, from easy retail investments to drilling programs for sophisticated investors. Each have a pro and con that we will address. Below is a list of six basic investment vehicles:
. Stocks in Oil Companies
. Working Interest Partner in a Drilling Program
. Existing working interest in a lease.
. Stock in royalty trusts
. 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 -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 its 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 http://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). 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 dominant and preferred investment of individual investors in the oil industry.
On that note, here’s how the global import/export picture has changed for oil and gas during the period spanning from 2006 to 2012:
The crazy thing is that over just the past two years, America has skyrocketed past Russia and Saudi Arabia to the top of the world’s oil and gas production charts.
Now, it is just a question of time before that abundant supply begins exportation to the vast benefit of the American consumer and investors.
But as usual, when it comes to energy, there’s politics involved.
Here’s what former U.S. Congressman James Bacchus had to say on the subject:
Advanced Valuation Metric For Oil and Gas
When most of us hear the words “Monte Carlo” we think of high-stakes poker games, fast cars and beautiful people strolling on a sunlit beach.
When it comes to investing money in oil and gas, however, a Monte Carlo analysis or simulation is a different story altogether.
Take a look at how the pro’s do it…
The International Perspective
Another great way for oil and gas investors to understand the subject is to look at the international ramifications.
For instance, Jeff D. Opdyke, editor of Profit Seeker, predicts a huge oil and gas investment opportunity looming in Burma:
The country’s not much when you look at it. The political situation is in disarray and confusion, and despite attempts at democratic reform, the military still maintains a tight reign over the people.
But if you look beyond the veneer, the oil and gas market in Burma could represent a valuable yet timely opportunity in an economy that has, until recently, been suppressed by tight government scrutiny.
Back in the summer of 2012, I was one of the first Western financial writers to enter the newly open economy that, only months earlier, had been under 40 years of lock down by military lunatics running the government.
I remember hopping into a cab near the river front in Rangoon, Burma, to notice a rusted, gaping hole in the floorboard, leaving the pavement exposed beneath my feet. By that point in the trip, however, I’d become accustomed to the bedraggled nature of Burma’s fleet of ancient cabs, including VW buses from the 1970s that spew exhaust into the cabin.
Last week, I returned to Burma to research my latest book. And my how times have changed.
Granted, the place remains one of the poorest countries on the map. That’s just not something you fix overnight. But capitalism is conspicuously alive. All the cabs are new Chinese Chery compacts or modern Nissan and Toyota wagons. There are even new Mercedes and BMW dealerships that have opened in the last few months.
All of which means investment opportunities in the oil and gas market in Burma are clearly abundant for those who understand that the biggest gains always accrue to the earlier arrivers.
In 1853, Burma drilled her first oil well – six years ahead of the United States – making the country now known as Myanmar one of the world’s first oil producing and exporting nations.
For the better part of six decades, Burma’s bounty of natural resources – including an estimated .2 billion barrels of oil – lay locked behind a wall of secrecy, mismanaged by a military dictatorship so deranged that it once forced farmers to grow nut trees because fortune-tellers insisted nuts would improve the military’s strength.
But those real nuts in military have stepped aside to allow democracy and capitalism to gain a perch. And they’ve cleared the way for a host of exploration, production and oilfield-services companies from around the globe to claim their piece of the oil and gas market in Burma.
Which means energy is one of the primary industries we want exposure to as Burma re-emerges after decades hidden from view.
China is already tapping into the country’s reserves,
They are spending $2.6 billion building pipelines across Burma from the Bay of Bengal to China’s Yunnan Province. That pipeline will cut nearly two weeks off the transit of Middle Eastern oil destined for the Middle Kingdom, and will allow tankers to avoid the pirates plying the Strait of Malacca.
It will also give oil-and-gas production companies in Burma an easy, direct link to one of the world’s thirstiest energy consumers. India, meanwhile, recently showed up in Burma after a 25-year absence and is now eager to put its own taps into the country’s reserves.
As an investor in emerging and frontier markets for the last 20 years, I have searched for exactly the kind of opportunity that Burma’s energy industry represents. I know, though, that some are nervous about putting their cash to work in a country where democracy is still finding a foothold.
That’s the dichotomy of Burma today: Invest early and deal with the risks as your money doubles or triples in value… or rises 10- or even 100-fold. Or wait, and lose out on one of the last opportunities to invest in nascent capitalism.
Furthermore, Charles Ackah, Eric Mochiah, Oliver Morrissey and Robert Darko Osei tackle the thought-provoking question of how to manage the economy of an oil rich country in their case study of Ghana:
As you can see, the oil and gas investment picture is a complex one and should be viewed as a lot more than a mere buying and selling opportunity.
Oil and Gas Royalty Interest
Some of the benefits of owning an oil and gas interest run the gamut and in general are less riskier than owning an actual well. Owning a well introduces a host of problems including messy liability issues and also major expenditures for production.
Owning interests in oil and gas will remain in perpetuity. This means that although the working interest of a particular well may change hands several times, the interest of the royalty holder will remain intact throughout these changes.
Holding oil or gas royalty interests has the added benefit of no liability issues.
Liability issues can be between the working interest and the government or between the subcontractors and the operators of the well itself. There are environmental liabilities that must be considered, property damage, injury, and of course common liability issues with debtors and even a company going under. Liens held against the operations of the well can also occur which places those with working interest at a disadvantage if there are injuries or a lawsuit is brought again the company producing the resource.
Another benefit is that there are no extra costs associated with owning an oil and gas interest. The working interest is the sole responsible party in all of the operational costs for the well. This can include metering, plugging, pumping, up to and including abandonment.
Luck as in most investments in life can also play a big part. Though not actively involved in the production, sometimes more wells will be drilled on the same lease which means that the owners of the oil or gas interest will benefit from the extra sales following production from the new wells. All again without the operational cost.
Unlike in real estate and other types of investment, no capital calls are allowed. Those holding interest in oil or gas will never have to worry about requests for payment because those interest holders are divorced from the actual operation of the well such as drilling.
Another nice feature is utilizing an oil or gas interest to diversify a portfolio. Some investment programs involve working interest deals which are heavy on the risk and liability but feature huge payouts. Gauging the commodities market is certainly not for everyone and putting one’s trust into the hands of an operator who may turn out to be a detriment is extremely risky.
Having a oil and gas royalty interest is a safer way to get involved in energy production without having to worry about the excessive costs. Finally, monthly cash flow is a huge bonus in the form of checks from operators as royalty holders are paid first.
The Eagle Ford Opportunity
Expert Joe Barone alerts that, hydraulic fracking, has proven to be one of the most successful ways of retrieving natural gas reserves within shale.
Nine of every ten natural gas wells in the United States use fracking to access the deposits. Several shale plays in the Unites States are currently producing natural gas at an unprecedented rate. Of these, the Eagle Ford shale play is considered one of the most promising.
The Eagle Ford shale is an area beneath South Texas that extends 400 miles in length and 50 miles in width. The plentiful liquids and low drilling costs give this region the potential to be one of the most productive natural gas reserves in the nation. Projections far exceed any other shale play, primarily because of the heavy liquids the area contains. It is one of the only regions that have high levels of oil as well as both wet and dry gas. Rapid development is likely in this type of geological domain.
Eagle Ford has several advantages over the other shale plays. One is an advantage in its proximity to many of the North American energy markets, which are located in or near Texas. The region also already has an extensive infrastructure with more proposed and easy access to systems already in place for processing and shipping. These favorable conditions have influenced the projections and estimates for future production.
Already, growth in the Eagle Ford has been exceptional. From the beginning of the exploration and production in the area five years ago, the gas production in the Eagle Ford shale has gone from almost nothing to about 500,000 barrels per day. Bentek, an energy research firm, predicts that output is likely to grow from the current level to at least 800,000 barrels per day in the next three or four years.
Since most of the drilling has targeted the portions of the region that are more favorable for oil rather than natural, the fact that it accounts for around five percent of the United States’ total onshore natural gas production in the Lower 48 states is significant. The size of the Eagle Ford region offers a promising future to the natural gas industry in Texas.
What makes all these figures even more impressive:
Only about 60 percent of the natural production that comes from the Eagle Ford region comes from wells that target the areas of the play that are most likely to produce that resource. The other 40 percent of the natural gas production is almost what could be called incidental, because this has resulted from wells aimed at producing oil and liquids. All of these factors have resulted in extremely favorable predictions for the oil and gas companies who have invested their resources extensively in Eagle Ford.
Even the most advanced of the current methods for capturing and processing natural gas are not necessarily efficient options; so many companies are working to create better methods. More pipeline and other infrastructures to process and ship natural gas are also necessary. Once these are in place, expectations for the natural gas output from Eagle Ford may increase rapidly, resulting in an even greater output for Eagle Ford, as well as other shale regions in the country.
Tank Farms: A Huge Hidden Secret
Amit R Kumar alerts us to a little-known, but hugely-important tool in the oil and gas investment field. You may not ever be able to invest directly into a “tank farm” but knowing what it is can help you ask important questions at the time of your choosing to invest in oil and gas.
Tank farms are a peculiar sight to see. Rows and rows of towering oil tanks stand imposingly. They are an integral part of oil and gas logistics. Companies invest millions of dollars in building robust and efficient tankers. The latest technological advancement ensures these tanks are controlled automatically with minimal manual supervision. The input and outflow are controlled by the systems and human intervention is needed only in cases in deviation and emergency cases. So why are it vital in oil infrastructure?
Benefits of Tank Farms
1. Control demand spikes
Oil and gas have fluctuating demand and any small shortage can significantly impact the global crude oil prices. Oil fluctuations have the potential to shatter world economies. Their proper functioning ensures consistent oil supply no matter what the demand. They aid in controlling the flow of this precious natural resource. Terminal automation systems with their integration with ERP (Enterprise Resource Planning) systems ensure that there is no adverse effect on the supply of natural gas.
2. As a trading mechanism
Oil is used as currency where normal trade is not possible due to a number of factors. it ensure that there is ample amount of oil to trade in and store as surplus. Oil rich nations often use oil as a bargaining tool in a barter exchange. If such tank farms collapse or face any maintenance issues, it will put a spanner in many negotiating deals.
3. Oil integrity maintenance
Oil is a complex compound, but prolonged exposure to natural elements erodes the capacity of oil, this decreasing its quality and value. High quality oil demand great premium in the market. it ensure that oil and gas are stored under optimal condition with no outside foreign material interference. This ensures maximum integrity in the natural oil compounds.
4. Variety of oils
Tank farms are utilized for a various types of fuel like diesel, heavy fuel, jet fuel, crude oil and other chemicals. This ensures the maximum value for money as firms do not need to invest in multiple farms for different types of oil. Terminal Automation Solutions provide the flexibility of internally managing the oil tanks for different projects and storage. Tanks are cleaned automatically and features set with automated systems while interchanging oils.
Oil is a heavily flammable material. It incorporates the latest safety features and other tools to ensure maximum safety. Personnel managing tank farms are adequately trained in emergency prevention and other fire management techniques. Tank farm operations systems provide alarm and notifications in case of any deviations from standard protocols. A timely response is made possible with the help of them.
It are often projected as the symbol of a nation’s industrial strength and rightly so. Proper management makes its economically viable solution for the oil majors.
FUNDAMENTALS OF INVESTING IN OIL AND GAS
by Chris Termeer
There are many books available on oil and gas investing but “Fundamentals of Investing in Oil and Gas” by Chris Termeer may be the best way to get the whole story on a very complex, yet potentially infinitely rewarding marketplace.
There’s everything from the history and creation of the marketplace, how oil and gas are found, extracted and transported. From there we move on to the refinery, otherwise known as the Midstream Sector of the industry. The Refining or Downstream Sector of the industry is then thoroughly explained in aspects of the creation of gasoline and other highly demanded products. Once the whole industry is explained and analyzed, Termeer digs into present and potential future trends that every investor will want to read about it.