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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Forget Oil Majors, Stripper Wells Offer Better Returns

As stock markets continue to collapse with publicly traded energy producers bearing the brunt of that fall, investors should be reminded why it is important to diversify their portfolios. Of course that means investing in both the energy sector and other areas, but it also means investing in different types of energy sector assets. The graphic below illustrates this point. USO is in blue, while the stock prices for Exxon Mobil and Continental Resources are in yellow and orange respectively.

(Click to enlarge)

As the picture shows, it has been a miserable 12 months for all three assets. Oil itself in the form of the USO security has had the worst time of it, but none of the three have been good choices. Bonds have not fared much better unfortunately. There are not too many ETFs out there that are specific to the energy sector, but one look at the high yield bond ETF (JNK), which has significant energy exposure demonstrates that bonds have not been a good safe haven either. Related: $30 Oil Will Accelerate Much Needed Rebound

In this environment, investors who are serious about the energy sector can consider diversifying into physical/real property assets in energy. This is an opportunity for large and small investors alike. Thanks to the internet, multi-million dollar portfolios are not required to hold real property investments.

Small investors can easily invest in energy related real property in one of two ways: investing in strippers and investing in royalties.

Strip oil wells produce small amounts of oil each day – far too little to be of interest to most publicly traded firms. But they produce this small amount of oil at a much lower overhead cost. The average investor may not want to own their own strip oil well (though some investors I have talked with do go this route). Related: Oil Markets On Edge About Fed’s Decision Tomorrow

But even for those looking for a more hands off approach, co-investing beside a stripper is a viable option. Particularly in the current environment, there are many strippers looking for capital infusions to help develop new projects. These investments can be attractive and if they are structured properly, they can be safe as well. Finding strippers looking for investors is reasonably easy through google.

In addition to investing alongside strippers, investors can also consider buying royalty rights to existing fields. In a fashion similar to publicly traded royalty trusts, investors can buy the rights to part of the production from existing oil fields. Unlike publicly traded royalty trusts though, these production rights can be quite small and can be tailored to the individual investor’s needs. Some royalty rights go for as little as a few thousand dollars. With oil prices at historically low levels, the prices on many royalty rights have come way down, and more owners are looking to sell. This creates an opportunity for those who believe in the long-term future of oil prices but do not know when prices will eventually rebound. Related: Finally Some Good News For The U.S. Oil Industry?

There are a variety of websites out there that let investors buy real property investments in oil and gas. The current miserable energy investing market is a perfect time to consider these options; to paraphrase a famous investor, the time to buy is when blood is running in the streets.

(Disclaimer: I am NOT recommending any of the above linked investments, nor condemning them. I am merely holding them up as examples of an opportunities in the sector. Investors should do their own due diligence. If an investor cannot do his or her own due diligence, then they should stick with more conventional investment choices.)

By Michael McDonald of Oilprice.com

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  • johnbozeman on December 16 2015 said:
    really, really foolish to invest in individual wells, stripper or otherwise unless you are very, very sophisticated (lots of money you can afford to lose plus experience OR experienced help you can TRUST)...the royalty trusts have some good points but many come with awful downside (maybe zero value at some point) you don't seem to dig very deep..

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