The industry will always have an upside, as long as investors remember these 3 keys to success
By Kevin Thibeau, President of Wheeler Resource Recovery
As we near the end of a year marked by tremendous upheaval, countless investors have been scared away from the stock market. Early in the year, bank deposits grew at a pace not seen since the 1970s, according to Barron’s, with cash levels now topping $15 trillion. With another $5 trillion parked in low-risk money market funds, investors are arguably facing a new kind of risk: the risk of missing out on smart investments due to fear.
Investors looking for upside aren’t limited to the stock market, though. For those hoping to get some money into investment vehicles before the end of the year for tax purposes, the oil and gas industry shouldn’t be overlooked. Despite hand wringing over the future of oil and gas, the reality is that most of the world’s infrastructure is currently built on it, with demand growing in many countries. Even if electric cars grow in popularity domestically, it will take decades to replace all existing cars. Put another way, a full move to electric is simply not going to happen in our lifetime.
Investing in an oil and gas project, when done correctly, can be relatively low risk/high reward. Of course, investors should still approach any investment with caution, evaluating the opportunities presented to avoid investing in fool’s gold. With that in mind, here are the top three things to consider when choosing an oil and gas project investment.
1. Insist on a proven track record. In the oil and gas industry, primary drilling is the first phase of oil recovery; it involves identifying a field, drilling a well, and then determining whether you can produce oil at all. With primary recovery, there are sometimes sketchy actors who only drill one or two wells a year. If a company doesn’t have a verifiable track record, approach the project with tremendous caution.
Secondary recovery doesn’t involve discovering oil, but re-pressurizing a proven, existing oil field with water to get most of the oil out. Having this known source of oil greatly reduces the risk of the investment. Still, investors should do their research on a company’s track record and only invest if there’s proven past success.
2. Ask if the company has a stake in the project. A strong indicator for potential oil and gas investors is when the company running the project actually has a stake in its success. Certain companies seek to raise funds before ever producing oil, while also having none of their own money at stake in the project and solely relying on investor funds. It’s far preferable to have shared responsibility and cost with the project’s owner, meaning they only make money if you make money.
3. Calculate the ROI. The attractiveness of any investment is closely tied to operational costs and the ability to produce oil efficiently, which both impact profit, as well as potential tax benefits. To use an earlier example, primary drilling is expensive with high upfront costs. For instance, the breakeven point for drilling a deep horizontal well with many fracture stages in the Bakken oil field is about $46 a barrel.
Secondary recovery, however, offers significant cost advantages. First, it incorporates the re-cycling of formation water, instead paying for the disposal of that water which is an added cost of primary recovery. The water taken out of a producing well can be re-injected back into the ground as a drive mechanism, which breeds cost efficiency. The breakeven price can be much lower; we have seen some efficient projects with a breakeven point at $15 a barrel. So even in a world where oil and gas prices are low – you can still make a profit.
Secondary drilling also comes with unique tax benefits; you can now write off 100% of intangible drilling costs the year incurred as an expense against income you receive from sources unrelated to the oil project, and 15% of all oil revenue is essentially tax-free in the form of a depletion allowance.
The Bottom Line
While 2020 has been a wild ride, investors should not stay on the sidelines out of fear—just as they shouldn’t avoid the oil and gas industry because of trends that are decades away. The reality is that our planet’s reliance on fossil fuels is here to stay for the next twenty years at least. That means oil and gas remains a viable investment, so long as investors do the proper due diligence and know what to look for before drilling too far down.