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When considering investing in oil and gas drilling ventures, only risk capital should be used. As with any investment, if you are not comfortable risking the loss of money, then you are investing too much. This level of comfort differs for each investor. You need to decide what your comfort level is. Once decided, follow an investment strategy that maximizes your returns while minimizing your losses.
A basic strategy for oil and gas drilling investments:
· Don’t invest in only one or two wells. Reduce your risk by spreading the available funds over several wells.
· Invest approximately the same total funds in each oil and gas drilling project. Using the same amount of funding keeps you disciplined and consistent. You wont be as susceptible to an oil producer trying to more in one project since it is a “sure thing”.
· Only consider investing in wells that are projected to return your investment in 6 to 18 months.
· Develop a reinvestment plan into additional wells. Decide what percentage of oil/gas revenues from your wells to should be reinvested in additional wells. This way your income continues to rise from consistently adding new wells at the same time your older wells start dropping in production.
Consider an example of diversifying over several wells:
Let’s look at an example showing how diversification provides the best combination of risk verses return. In this example you have $100,000 total to invest. You invest approximately the same portion of this money across four wells. It is may be impossible to invest exactly the same in each well since the cost to participate may differ from well-to-well.
When the wells are complete and in production, we see the various monthly returns for each and further see that well #2 turned out to be a dry hole or non-producing well. The return on investment with the other three wells varies from a high of 200% to 67% with an overall combined return of 93% across all four wells.
Had you invested the full $100,000 in well #1, the total return would have been maximized. However, you would have risked losing all of your funds had it turned out to be a dry hole like well #2. Alternatively, had you only invested in two wells with the dry hole well #2 being one and either well #3 or #4 being the other, your combined returns would have been much less than the current diversified 93% across the four wells. Therefore, investing everything in one or two wells hoping for a 200% ROI Well #1 is not worth the risk, and misses out on the strong diversified 93% ROI.
A long term strategy for oil and gas drilling investments:
Every well runs dry at some point in the future with some wells only lasting a short time while others last for many years. It is important that you continually add to your portfolio of oil and gas wells to replenish lost income from the older wells as they slow down. As stated earlier, a portion of the income from your wells should be reinvested into additional wells. Beyond trying to maintain the same level of combined income, you should consider reinvesting even more so your resulting yearly income is always increasing. Over the long run, continued diversification will minimize your risk of loss while providing consistently increasing income. Another reason to continue reinvesting in additional wells is to take advantage of the tax write-offs against the income from these wells.
Consider an example of reinvesting oil/gas income into additional wells:
In the previous example we received a combined 93% ROI over four wells. This means we will receive $93,000 income from those wells in the first year. If we reinvest a little over half of that into two additional wells at $25,000 each, then the resulting income would be significantly higher while lowering our risk over more wells. This assumes the first wells continue to provide a strong payout after the first year.
Scale up your investments as income grows:
Continuing this strategy provides you with increasing income that is debt free. You are using income to buy additional income. This is a very powerful way of having your money work for you to increase your wealth. Eventually, as your income increases, you will be able to participate in larger projects while increasing your percentage ownership in the associated partnerships. You could scale up your average investment per well from $25,000 in this case to $50,000, then $75,000, etc. This may mean purchasing additional percentage ownership in these projects or participation in larger projects that require more funds per percent ownership. Also keep in mind that ongoing investment in additional wells provides associated tax write-offs against the growing income stream.
Your input is desired for future article topics:
We want to hear from you. What oil and gas investing related questions to you have that we have not already covered? Please email topics you would like us to consider at our generic email address MarcobeInvestmentsInc@gmail.com. Also, email us if you have any other thoughts or questions for us to answer. Thank you.
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Copyright 2008 Ole Cram. Ole Cram is President of Marcobe Investments, Inc., a corporation that invests in various oil and gas ventures and refers accredited investors, investment managers, financial advisors, investment funds, and others to the associated oil producer of these projects for their consideration to also participate. Feel free to email us at MarcobeInvestmentsInc@gmail.com with any questions, thoughts, or requests for information on what projects we are invested in.
This article was posted at Accredited Investor Blog: http://accreditedinvestortalk.blogspot.com/. Past articles can easily be found at http://www.MarcobeInvestmentsInc.com/Oil_and_Gas_Investor_TOC.html. This article is provided for educational purposes only and is not meant to be a substitute for tax, legal, financial, or other registered professional advice for your specific situation. Always seek the advice of a professional before making any related decision.
