Potential investors in oil and gas drilling projects are naturally interested in the future cost of oil, since it directly impacts potential investment returns. I’m including gas well drilling projects, since there has traditionally been a close association between the prices of the two commodities. With crude commodity prices pushing $60 a barrel, I thought this might be a good time to revisit the subject:
In early April, an analyst at Goldman Sachs, created a furor with this statement: “Goldman Sachs said that the oil market may be in the early stages of a ’super spike’, which could push prices as high as $105 a barrel.” Then in late April Business Week On-Line reported that Tim Evans of IFR Energy Services was predicting an impending drop to the $26 to $30 a barrel range. In the meantime, US Department of Energy’s Energy Information Agency as recently as June 7th was forecasting an average of $53 a barrel for oil in the 2005 third quarter and providing charts showing a high 40’s - low 50’s price through 2006.
In the company of these widely varying expert opinions, mine will not carry much weight. Nevertheless, I believe oil will trade between $45 and $65 a barrel over the next 12 months. Why? Because, if oil trades above $65 a barrel for any prolonged period, we should see a significant increase in inflation, followed by a contraction in the US and world economies, thus reducing the demand for oil. Below $45 a barrel, OPEC will likely cut back on the supply and thereby prop up prices. After all, the US has already proven that it can keep the economy growing with oil trading in the $45 to $55 a barrel range. So OPEC has little incentive to let the price drop below the $45 a barrel level.
While oil at current prices makes even potentially marginal drilling projects look attractive, the prudent investor will look more favorably on oil and gas investment offerings that can provide a decent return on investment even if oil once again trades down in the $25 to $30 range.
The most common way to invest in oil and gas is to buy shares of stock in one or more oil/gas exploration-production companies. These companies range in size from relatively small Valero Energy Corporation (VLO) to giant Exxon Mobile Corporation (XOM).
Futures and options are another way to invest in oil and gas.
Here the investor is either buying (a) a direct interest in a producing well or property, or (b) an interest in a partnership that owns an interest in a producing well or property.
In this situation a investor either buys an interest in the partnership formed to drill a well, or buys an interest directly in a well that is to be drilled.