Sitting out inflation isn’t a sound strategy. Now’s the time to invest in oil and gas.

By Kevin Thibeau, President of Wheeler Resource Recovery

Investors tend to dread inflationary economies. Rising inflation negatively impacts stock prices because it can increase input costs such as materials and labor, reduce standards of living, and hike borrowing costs. Mostly, though, inflation tamps earnings-growth expectations, and that pressures stock prices downward.

Sitting on your money in an overheated economy isn’t a good financial decision either, because inflation is actively decreasing the value of your cash. Instead, savvy investors must look to turn their cash into hard assets.

This is one reason oil and gas investments can be particularly attractive in an inflationary economy – particularly as gas prices reach an all-time high since 2014 with no signs of slowing down. If investors act promptly and approach opportunities wisely, they can take advantage of periods of higher inflation, coupled with the high cost per barrel of oil, to reap the rewards of investments in oil and gas.

Why Inflation Shifts Investing Strategy

Inflation that many economists expected to be short-lived in early 2021 has stayed with us. The core personal consumption expenditures price index – a key gauge of inflation used by the Federal Reserve – rose 4.9% in 2021. That’s the biggest leap since 1983.

Likewise, headline inflation climbed 5.8% to tie the fastest pace of growth since 1982. Energy prices alone shot up nearly 30% throughout 2021. In response, central bank officials are likely to begin raising interest rates as early as March.

Rising interest rates can especially affect growth stocks and dividend stocks. For growth stocks, notably small caps, earnings expectations are typically for the future, and climbing interest rates reduce the current value of future earnings streams. Plus, as returns on government bonds increase, bonds become more appealing. For dividend stocks such as REITs, bonds also become a tempting alternative, because dividends often fail to keep up with inflation.

But an even more attractive strategy is to turn cash into hard assets. And with an informed approach, investing in oil and gas is particularly promising. That’s especially true at a time when Henry Hub prices – the pricing point for gas futures contracts on the New York Mercantile Exchange (NYMEX) – are up about 70% year over year and driving share-price performance.

The Investment Potential of Secondary Recovery

Another reason it’s a good time to invest in oil and gas is that nonspecialized private equity firms aren’t currently focused on the industry. These firms typically back exploration, drilling and production startups that then sell to larger producers or go public. But right now, investors are asking publicly traded producers not to take on debt to drill new wells.

In this capital-constrained environment, oil and gas producers become more attractive to investors outside the industry. Secondary recovery projects in particular have above-average return potential and maximize extraction of oil reserves that already exist. With a lower risk and higher reward, secondary oil is fitting for nontraditional investors with lower risk tolerances.

For example, Wheeler Resource Recovery is developing a “waterflood” project on 1,078 acres in Madison County, Texas. This involves drilling 27 injection wells and 27 production wells to produce from the fertile Woodbine Sands formation. Within a few months of applying the waterflood method, the field began generating revenue for investors.

Secondary recovery can have low breakeven prices, some as low as $20 a barrel. At a spot price of $35 a barrel, the recoverable reserve estimate at Woodbine Sands will generate revenue of $610 million on drilling costs of $100 million. At $50 a barrel, revenue hits $875 million. In January 2021, the spot price of West Texas Intermediate – the price used by NYMEX for crude oil futures contracts – was around $84, up from about $52 a year earlier.

Now’s the Time for Oil and Gas Investments

Of course, investors could indirectly support such waterflood projects by buying stock in large publicly traded companies like BP or Exxon. And they might see up to 8% annual returns.

But a more promising approach is to purchase small percentages of production and injection wells. Right of first refusal on future packages helps investors control risk exposure. And tax breaks are plentiful. Investors can deduct 90% of invested funds, while 15% of collected revenue is tax-free.

When considering such investments, evaluate the opportunity by asking three essential questions:

1. Does the producer have a proven track record? Secondary recovery involves repressurizing a proven oilfield to produce as much oil as possible. Don’t settle for inexperienced producers that drill only a few wells a year. Make sure the producer can point to past success.

2. Does the company have a stake in the project? Some producers have little of their own money tied up in a project or try to raise funds before they’ve produced a drop of oil. Manage your risk by investing in a company that shares the risk, making money for themselves only when they make money for you.

3. Have I calculated the potential return on investment (ROI)? The potential of an oil and gas investment is closely tied to the ability to produce oil efficiently. It’s also linked to tax benefits. Make sure you understand breakeven costs, and whether operational costs will be covered by oil production.

Nontraditional oil and gas investors – those with limited industry experience but a keen investment sense – will recognize the opportunity currently presented by oil and gas investments.  Now’s the time to respond to a period of inflation by converting cash to hard assets – by investing in oil and gas.
Interested in learning more? Contact us and we can connect about investment opportunities that are right for you.