How to Profit From Oil and Gas Investments

Table Grape Field and Oil Well

Looking for a good investment? Oil and gas may be the alternative you're looking for. It's the most tax-advantaged investment available in the U.S. for those investing either through partnerships or directly at the wellhead.

Instructions

1. There are several ways that you can invest in oil and gas. For high net worth investors, the three primary avenues are via commodities futures contracts and options, partnerships and direct working interests. Most partnerships require buyers to qualify as high net-worth investors, but anyone can invest directly at the wellhead. The trick is to find a reliable seller who is honest and upfront in their business dealings (which can be a challenge many times in the oil and gas business.) But the best type of property to find is one that is underproducing, with potential for rework or additional drilling. This type of property offers tremendous upside when it is developed.

2. In order to develop properties with potential, you will probably need to enlist a petroleum engineer. He or she will be able to do or direct the necessary improvements to the property to make it profitable, or more profitable. Remember that virtually all costs associated with oil and gas property development are deductible, either immediately or over a 7 year schedule. But there are hundreds of petroleum engineers available to do this type of work, either in the yellow pages or online.

3. After you find an engineer to work with, get an estimate of the costs and expenses involved in reworking a particular project. (Your engineer may also know about several profitable projects that are not listed anywhere that you can invest in.) Your engineer should be able to give you at least a preliminary cashflow analysis breaking down the income versus costs of a given project (and if you can't get this, then don't invest-period.)

4. After you purchase your lease (if you buy a working interest), then you should receive a title deed for the lease just as you get one for your house. This deed entitles you to all working interest income that is generated from your lease, or at least to the percentage of the project that you bought. But don't forget to write off 15% of all working interest income with the depletion allowance before computing taxable income. Then deduct all drilling and rework costs before computing taxable income.

5. For those in the lower net worth categories, there are several other types of investments available that provide exposure in the energy sector. Perhaps the most common is through mutual funds. Your broker or financial advisor will probably have some suggestions, or you can go online to www.morningstar.com and do a search for energy funds on their site. Morningstar.com tracks this sector specifically and can rank all available energy funds according to a variety of criteria, such as total return, volatility, costs and fees and historical performance.

6. There are many individual stocks of energy companies for those seeking higher returns with greater risk. All of the major oil and gas companies are publicly traded, and you can buy these stocks either through your broker or online. Again, your broker may have some recommendations, or Morningstar.com can provide analysis here as well. Or you can buy preset groups of energy stocks through Unit Investment Trusts such as those offered by First Trust and other companies.

Tips & Warnings

• One good place to find oil and gas properties for sale is www.plsx.com. For more information on oil and gas investments, consult your financial advisor.

• Oil and gas is still in many ways the wild west of the investment frontier. Don't hesitate to employ an experienced oil and gas attorney to ensure that all paperwork is done correctly. Also remember that all income realized from a working interest is subject to self-employment income; for this reason, those with income above the Social Security wage base can benefit more from this type of investment than others. Stock, futures and mutual fund energy investments are volatile in nature and should be avoided by conservative investors.