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Investment in the Oil and gas sector is by no means a high risk/ high yield venture. Having the right information and knowing the right investment portfolio for you is the key to maximizing your investment and in some dire cases, the difference between making a killing profit and bankruptcy.
Investors have many options when getting involved with oil. These methods come with varying degrees of risk and range from direct investment in the oil and gas industry, to indirect exposure in oil commodities through the ownership of energy-related equities, futures and options.
Direct investment in Oil and gas involves the purchase of equity in any of the various physical businesses involved in the process of drilling through to bringing to market of refined crude Oil. There are distinct advantages of direct investment in oil and gas industry as opposed to the purchase of stocks of oil companies. Direct Oil and gas investments provide investors with an opportunity to diversify their portfolio and generate monthly cash flows while taking advantage of substantial tax benefits allowed by the US government. Each investor receives a share of the profits generated by the wells they own. In worst case scenarios where exploration hits a dry well, investors can recuperate their investment in a 100% total write off in losses.
There are several factors that encourages the direct investment in oil and gas: one of such factors is that the investor is more engaged directly in management of his funds and will get commiserate compensations in the event of success in the project unlike investment with public oil companies, where significant drilling successes tends to be highly diluted at the individual shareholder level.
In direct investment also, profit potential as a result of increase in the price of oil and gas is significantly higher due to fewer administrative layers. Even more so as the prospect of profit, so is the increase in associated risk. Many private oil and gas projects encounter mechanical and geophysical risk. To mitigate this risk, some investors may choose to build a portfolio of companies to spread their risk across a number of companies.
Indirect investment in oil commodities in the oil and gas sector refers to the purchase of energy-related equities on the stock market, through mutual funds / ETFs or a slightly direct method of investing in oil futures and futures option. All of these investments have their own risk/reward profiles. For instance an investor who doesn’t want to get into the complexities of directly investing in oil and gas companies but can’t resist the lure of the black gold or even if the purpose for investing is diversification, can purchase stocks of publicly quoted companies involved in exploration of oil.
Another way an investor can allocate a portion of his investment portfolio in the energy sector is through mutual funds or ETFs (Exchanged-Traded Funds). This allows the investor to buy into a basket of companies of energy companies and spread his investment in the entire energy sector, from the oil exploration, drilling, refinement, transportation and storage. The key is to find the low-cost and diversified energy sectors for your money worth. ETFs trade on a stock exchange and they can be purchased and sold in a manner similar to stocks. For example, buying one share of the U.S. Oil Fund (USO) would give you exposure to roughly one barrel of oil. ETFs, like the iShares Global Energy Sector Index Fund (IXC), and energy-sector mutual funds, like the T. Rowe Price New Era Fund (PRNEX) invest solely in the stocks of oil and oil services companies and these investments come with lower risk.
The purchase of Oil futures and Oil futures option is another way through which investors can invest in the oil commodities. Futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset, such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash. Futures are highly volatile and involve a high degree of risk. Additionally, investing in futures may require the investor to do a lot of homework as well as invest a large amount of capital.
Deciding on what best suits you, will require you consult with financial services professionals in the energy investment industry. They can offer investment advise when they understand your expectation’s including your investment objectives, tax considerations, risk tolerance, liquidity and time horizons. Understanding your financial circumstances enables them to advise a strategy that would reduce the risks associated with investment in the oil and gas industry, while increasing your chances for success.