Is investing in oil a good idea? In this precarious market, it’s not an easy question to answer.
Learning how to invest in oil wells and gas requires a studied understanding of the evolving market. Over the past three years, investments in oil have seen radical ups and downs. While it can be impossible to time the market, wise oil and gas investments could help you make a significant profit.
However, truly building wealth takes more than a well-timed investment strategy. The 1% have made trillions based on timeless financial principles that extend beyond where to invest your money.
Learn the financial secrets of the 1% with our free webinar “Surprising Secrets From the 1% Rulebook”, or read more to learn if oil investing is a good idea today.
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A Brief History of Oil Investing Since 2020
So far, 2022 has been a wild year for oil investments. Circ*mstances brought a perfect storm of increasing prices and demand, which is the exact opposite of what we experienced in 2020.
The COVID-19 pandemic initially destroyed demand, tanking oil investments, with Saudi Arabia and Russia getting into a price war to see who could go the lowest.
Oil and gas prices edged down, from a high of $63.27 per barrel (WTI) in January 2020 to $20, $19, $18. Then on April 20, 2020, the unthinkable happened: Oil futures went into a free fall, bouncing at negative $37 a barrel.
“A barrel of oil is cheaper than the price of beer,” stated a CNBC headline. Demand for oil wells and gas had fallen so low, that companies couldn’t even give oil away. Instead, oil and gas producers were paying tankers high fees to temporarily park unused oil.
Is Investing in Oil a Good Idea in 2022?
One year after the 2020 oil slump, crude oil prices experienced a tremendous rebound. In February 2021, oil prices hit pre-pandemic prices of $60 per barrel. Similarly, natural gas prices, which bottomed out in April 2020, rebounded. In 2022, oil and gas prices began skyrocketing, with crude oil costing over $111 per barrel as of June 2022.
So is oil and gas a good investment now? With prices on the rise, many are tempted to try and profit from the ongoing market frenzy. Investing in oil was highly profitable for many who took advantage of the low prices in 2020 and even 2021. However, trying to invest in oil and gas at current prices could leave you with little to gain (and possibly much to lose) once gas and oil prices even out.
Before further determining if oil and gas is a good investment, let’s look at four common myths when it comes to investing in oil wells.
Oil and Gas Investment Myths
Myth No. 1: We’re running out of oil and gas.
If you read the newspaper headlines before 2022, you might have thought oil production and demand peaked a long time ago, especially with the rise in solar, wind, biodiesel and other green alternatives. The idea of “peak oil” as popularized by the influential Club of Rome consortium of industrialists, scientists, economists and government officials turned out to be all wrong.
“The Limits to Growth” was published in 1972, an alarmingly pessimistic report based on Massachusetts Institute of Technology (MIT) computer simulations of economic and population growth, and resources perceived to be in short supply. The model predicted that all known petroleum reserves would be entirely used up by the end of the century at the same consumption levels. If consumption rates continued to increase, gas and petroleum would be gone by 1982.
What’s actually happened is we’ve gotten better at finding and extracting oil and gas. This is due to improved technology and new discoveries. In the United States alone, we now produce more oil than during our previously accepted “peak oil production” era of 1970. Today, the U.S. is the world leader in oil production, far outpacing Saudi Arabia by 57%.
Myth No. 2: Forget oil and gas investments. Alternative energy is where the opportunity is.
The truth is that energy demands around the world are steadily growing, and this demand is being met by both in alternative energy growth as well as oil and gas. As energy expert Alex Epstein argues in his book “Fossil Future”, more oil, gas and natural coal are needed to sustain human flourishing, not less.
Alternative energy is an exciting, booming industry with tremendous growth potential. It’s compelling for environmental reasons. It’s also not without tremendous risk and costs, some of which have been borne by taxpayers.
Some green energy technologies have shown themselves to be winners. The cost of solar and wind power continues to decline. Solar energy has proven itself so effective that solar energy storage is also now a viable industry. Additionally, electric vehicles are becoming increasingly common and desirable, which leads us to our next myth:
Myth No. 3: Electric vehicles have decreased the demand for gas and oil wells.
While energy sources are diversifying in the U.S. and around the world, the demand for oil and gas has not decreased. Oil consumption continues to rise, especially in countries such as China, India and the U.S. As the chart below shows, demand for crude oil has steadily increased since 2006.
In spite of the rise of electric vehicles, the demand for all kinds of energy has only risen due to population growth and higher quality of life around the world. Even as more people buy electric vehicles, we will always have a demand for oil due to plastics (which are made from petroleum), trucks and heavy equipment that require diesel.
Myth No. 4: The best time for investing in oil is when prices are on the rise.
At $104 a barrel (as of July 2022), many people are excited at the idea of investing in oil and gas now. However, while gains could still be made, it’s impossible to time the market and know when supply and demand will begin evening out.
You could still take advantage of rising oil and gas prices, but be aware: When you buy high, there’s an increased risk of loss once the rally is over.
How to Invest in Oil Wells and Gas
Whether you decide to buy now or wait, it’s important to learn how to invest in oil wells and gas when the time is right for you.
Many people believe the stock market is a great way to invest in oil and gas. Surprisingly, it may not be the best decision. That’s because oil and gas receive significant tax incentives to motivate the country toward energy independence. This means drilling costs in the oil and gas industry are up to 100% tax deductible. Investing in oil outside the stock market is therefore an excellent write off against income or gains in other areas.
Essentially, there are several ways to invest in oil and gas. Let’s look at three options along with some pros and cons of making investments in oil and gas with each:
Stocks and mutual funds
This could include ETFs, mutual funds, and large or small-cap stocks. Stocks could have a limited upside for shareholders, as most of the profits are reinvested. Additionally, large companies and their stock prices can be negatively impacted by oil spills and other negative press.
On the positive side, an oil-and-gas mutual fund or ETF offers some risk protection through the diversification of companies. And if you don’t have a lump sum to invest with, investing through the stock market may be your only option.
Unfortunately, shareholders won’t get a major benefit of investing directly: the tax write-offs.
Equity direct participation programs
Equity investments or direct participation programs (DPP) could be the most profitable way for most investors to participate in, investing in oil and gas. A DPP is a non-traded pooled investment that operates over a several-year time frame and offers investors access to an energy venture’s cash flow and tax benefits. (Investors may also be familiar with real estate DPPs, which operate in a similar fashion and—like oil and gas DPPs—can participate in 1031 tax exchanges.)
A DPP typically funds oil and gas development in multiple wells. In the first year, the benefit for the investor is the tax writeoff, which can be upwards of 85% of the investment. After about the first 12 months, when the drilling is complete, investors begin to receive a monthly dividend. The returns can vary from very modest to very profitable, depending on the success of the drilling. 15% of this income is tax exempt, and the remainder is treated as ordinary income. (Be sure to speak to your tax advisor for specific tax advice.)
After about five years, the well package is typically sold to a larger oil company. The profit from the sale is then distributed proportionately to investors, and returns are treated as capital gains.
Advantages of direct investments in oil and gas include:
- Asset class diversification
- High profit potentials
- Significant tax advantages
Risk can be somewhat mitigated through multi-well packages and experienced operators. However, investors must be aware of the disadvantages. Oil and gas investments are illiquid and speculative in nature. While returns can be significant, they can also be nonexistent. Profitability is affected by oil prices, and investments in DPPs are only available to accredited investors.
Mineral rights leases
Mineral rights leases are not an investment in oil and gas itself, but a private lending agreement that functions like a real estate bridge loan. Investors receive contractually-agreed-upon returns that can provide monthly cash flow. Investment time frames are usually between one and three years. Lump sums are required to participate in mineral rights leases.
Learn more about mineral rights leases in the ”Investing in Mineral Rights” episode of the Prosperity Podcast.
Is Investing in Oil and Gas a Good Idea for You?
Do oil and gas investments belong in your portfolio? Direct investments in oil and gas projects can bring substantial and nearly immediate tax advantages, while diversifying investments can potentially bring higher returns. Such benefits could make investing in gas and oil worth considering in your overall strategy.
However, be extremely careful when investing during a market rally such as the one we’re currently experiencing. Although prices of oil and gas could continue to climb, it’s impossible to know how long it will continue.
Deciding to invest in oil and gas may be a good idea for some, but not for others. While some prefer to invest their dollars toward energy alternatives, others are attracted to the more proven track record of investing in oil and gas. In any case, risk should be managed and choices should be weighed with the help of a professional financial advisor. Also, keep in mind some of the most attractive oil investments are for accredited investors only.
Start Building Wealth Today
Determining if oil investing is right for you now can put you on track to making wise investment decisions for the future. However, setting yourself up to build wealth for the long term requires a more holistic approach that the majority of middle-class Americans aren’t unaware of. That’s why the top 1% now hold more wealth than the entire middle class in the United States.
For generations, the 1% have passed down financial secrets that have helped build their families’ billion-dollar empires, while the vast majority of Americans live paycheck to paycheck.
Learn the financial secrets of the 1% by watching our free webinar “Surprising Secrets From the 1% Rulebook”. Otherwise, if you have any questions about building wealth outside the stock market, contact Prosperity Thinkers today.
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Disclosure: Our content is meant for educational purposes only. While it’s our intent to help you learn more about investing in oil, this article is not intended to serve as investment advice. Please consult your financial, tax or legal advisor before investing in oil or gas, or making any other investment decisions.
