Investing in oil is generally a good way of ensuring a return on an investment, with strong profits even at a time when the global economy is stumbling from macroeconomic events or geopolitical crises.
Not all oil investments are the same, however. For many people, the idea of investing in the major oil companies provides a degree of comfort and security, knowing that big names like ExxonMobil and BP likely are not going anywhere. Others like the challenge of beating the market in actively trading oil as a commodity on exchanges.
Neither of these options, however, really offer much for those looking to tap into the massive returns that oil companies themselves are seeing. Both oil company stocks and oil futures require investors to pay already high prices, then offer returns only as great as the change in the market, or any dividends a company might offer to its shareholders.
Instead, some people who are more willing to accept the risks prefer to invest in oil exploration and development directly, helping to pay for the up-front costs of constructing oil wells and the ongoing costs of operating the rigs in exchange for some of the high profits in selling crude oil.
The who and how of direct investment
However, investing in oil directly is not quite the same simple easy process as buying stock in an oil company. ExxonMobil, the largest publicly-traded oil company in the world, has some pricey shares as far as many people are concerned, ranging mostly between $80 per share and $87 per share through the first half of 2012.
But taking a share of an oil well is almost always mediated through an oil investment company. These companies, which specialize in pooling investor assets together to explore promising prospects, almost all deal exclusively with so-called accredited investors – those with enough capital to help significantly fund oil exploration costs and who can bear the risks these kinds of investments entail.
Accredited investors, as defined by the Securities and Exchange Commission, is any individual or couple with a net worth of at least $1 million excluding their primary residence, or an individual income of $200,000 per year or a joint income of $300,000 per year. There are different requirements for institutions such as banks, insurance companies and pension funds generally requiring a substantially higher net worth.
The reason direct investment is usually only available to accredited investors is that a single unit of ownership in an oil well will generally run in the range of $30,000 or more. While each unit offers potentially thousands of dollars per month in return, there is significant uncertainty about a well’s ultimate output, the timeline of production or the value of the oil once it goes to market.
Making the investment
Once an accredited investor has been put in touch with an oil investment company, these firms will generally send out oil investor kits including extensive details about the prospects they are currently planning to develop. This will include everything from maps of the location to magnetic spectrometry and seismology data for the ground down through the prospective drilling depth.
In addition, they will provide detailed projections of the anticipated output and the estimated reserves, with high, middle and low cases to allow investors to understand the worst- and best-case scenarios for the well. Combined with projections for oil prices, these can offer a realistic estimation of the value of an oil well investment. Because the investment is 100% tax deductible an example of the potential tax savings is also included.
Depending on the preferences of the oil investment company, such arrangements can take a variety of different forms from including limited partnerships, general partnerships, working interests or joint ventures.