Smart Money: Investing in energy with a comprehensive financial strategy
RENO, Nev. — The decision to invest in Oil and Gas (O&G) is both a tactical and personal one. Whether it is diversifying one’s portfolio, providing income, hedging against inflation, or owning a piece of Americana that was and is so instrumental in making this great nation, you are looking at oil as a calculated investment for your future.
O&G companies or assets can be invested through a broker or online trading platform just as you would any other company through common stock, mutual funds or ETFS focusing on the energy sector.
The most common way to own O&G is purchasing common stock of integrated oil and gas companies such as ExxonMobile (XOM), BP (BP) or Chevron (CVX). These companies are known as “Big Oil” (love them or hate them) as they are involved in the entire energy value chain from exploration, refining, production and consumer sale.
There are also specific segments such as mid-stream operators that are responsible for transportation, storage, and wholesale marketing of oil and gas products. Examples of these are Kinder Morgan (KMI), and Enbridge (ENB).
Other mid-stream operators are organized as Master Limited Partnership (MLPs). They have a different corporate structure and are traded on exchanges. However, instead of issuing shares, the company issues units.
These units represent an ownership in the issuing company and recipients are allocated a share of the MLP’s income, deductions, losses and credits. Due to this structure, MLPs cannot be held in tax-qualified accounts such as IRAs or 401ks. Spectra Energy Partners (SEP) and Magellan Midstream Partners (MMP) are two examples of mid-stream MLPs.
If investing in Big Oil isn’t your goal, it is still possible to invest in physical minerals that companies are extracting. Royalty trusts are trusts that hold mineral interests and the rights to royalties. These investments are not companies — they are trusts with terms and conditions such as a termination date, terminal value and productions that govern how they operate.
The reason royalty trusts exist is for companies to raise money to fund their operations within an oil or gas field by issuing and selling units of a trust. They use this money to extract the minerals and pay the trust royalties, which then pass on the investor.
The most challenging and difficult method in investing in O&G is the purchase of mineral rights (or mineral interests). Mineral rights are the right to extract, mine and/or produce any or all the minerals lying below the surface of the property.
These rights are not listed on any formal exchange. They are typically purchased privately; like one would purchase real estate. As mentioned above, mineral rights can be purchased through a royalty trust or can be held by a family trust or corporate structure and managed similarly as a leasing or rental company holding apartments or condos.
There are also different types of mineral rights: working Interest, royalty interest, over-riding royalty interest and non-participating royalty interest, each with its own privileges, restrictions, risk and reward.
Each of the tools above are methods in which one can enter the energy market — and as with any investment, prices of these investments change with the price of oil and gas and global macro-economic conditions.
Expanding the idea of correlation to equities, oil and the S&P 500 in recent years have generally moved together. The correlation was stronger during recovery; oil prices have since stabilized their dramatic run ending in 2014. Conversely, oil moved in the opposite direction of the U.S. Dollar Index and U.S. Bonds.
So now what? What does all this mean to an investor? The first step is research and analysis to determine value, the types of accounts specific assets can be held, taxation, liquidity and corporate complexity.
From there, one must decide how to incorporate them into a comprehensive financial strategy without inadvertently exposing oneself to undue risk while satisfying their investment goals.
Disclosure: None of the information provided in this article is intended as investment, tax, accounting or legal advice; an offer; a solicitation of an offer to buy or sell; endorsement of any company, security, fund or other securities or non-securities offering; or recommendation of any security in any jurisdiction where such offer, solicitation or recommendation would be unlawful or unauthorized.
David Millar, MBA, PMP, is the founder and president of Reno-based Motivesting LLC, an investment management and consulting firm providing lifestyle financial analysis and strategies to new and innovative investors. Visit motivesting.com to learn more.
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