Diversification. Oil and gas investments have provided a useful diversifier against the economy. When gas prices rise, economies tend to slow. This could cause the rest of your stocks and funds to stumble. But when oil and gas prices rise, oil and gas stocks tend to rise with them. Exposure to oil and gas stocks can help cover your profile against economic slowdowns. Which are caused by oil shocks.
Profit Potential. Investments in the smaller companies and limited partnerships can pay off big. A single well can generate many times its costs if drillers strike oil. And the well can pay dividends for many years.
Tax Advantages. There are some tax advantages to oil and gas investing. For instance, the IRS allows companies to deduct for depletion. An allowance that for depreciation in rental real estate. Which is a way of accounting for the gradual exhaustion of mineral supplies in a given plot of hand. If you buy shares in a traded stock, this benefit will be invisible to you. Since corporations don’t pass profits and losses to shareholder tax returns. If you buy a limited partnership membership, it could be an important consideration.
Volatility. Oil and gas investments can be subject to wild price swings. Especially when investing in smaller companies. If you get involved in exploratory drilling projects, you can lose a great amount of money. Diversification is the key to oil and gas investing. Losses of 50% or more are not unusual, and you can lose everything on any project.
Liquidity. While you can sell shares in larger companies, you may find it hard to sell shares in smaller companies. In some cases, you may have to redeem your interest with the company or limited partner. This is the case with held, traded companies and limited partnerships. Don’t become involved in these unless you are willing to tie up your money for a while.
Commissions. When you buy into a limited partnership or held corporation, you will pay a commission to a broker. These commissions tend to be much larger than standard stockbroker commissions. And can exceed 20% for very liquid companies. Any money that goes to a broker is money that doesn’t get put to work for you.
Complexity. Interests in held companies, oil wells, and other oil and gas projects aren’t for everyone. There are special tax rules that govern oil, gas, and mineral investments. And there are rules specific to limited partnerships that may affect you. Especially as you file taxes or account for shares when you sell them. We don’t recommend limited partnerships or MLPs. Except to very experienced investors who can take risks and commit for a long period of time. In a pinch, you may have better luck selling shares in an MLP than in a traded limited partnership.