Oil: Invest Now For Future Gains

Oil remains a key facet of the global economy, providing fuels for transportation and power, as well as the core ingredients for petrochemicals used to make plastics, rubber, and fertilisers. Despite the rise of electric vehicles, demand for oil and gas has not decreased, and oil consumption continues to rise, especially in countries like China, India, and the US.

While the oil industry is highly competitive and volatile, with profits and losses swinging wildly based on small shifts in demand, there are industry titans designed to thrive throughout the cycle. For example, companies like ConocoPhillips, Devon Energy, and ExxonMobil have diversified operations and access to some of the lowest-cost oil on Earth, allowing them to generate lots of cash flow and make money in almost any oil market environment.

Additionally, oil and gas stocks tend to be more volatile than the broader market, making them attractive to day traders. They can also serve as a portfolio diversifier and inflation hedge.

Oil is a key facet of the global economy

Oil is a crucial energy source, used in vehicles, planes, heating, electricity, and asphalt. It is also used in the production of plastics, paints, chemicals, tape, and many other products. The oil and gas sector employs millions of people worldwide and is a significant contributor to the GDP of many countries. For instance, in the United States, the industry accounts for 4.8% of the nation's GDP, while globally, oil accounts for approximately 3% of GDP.

The oil industry is highly competitive and volatile, with profits and losses swinging based on small shifts in demand or geopolitical tensions. Supply and demand imbalances can cause huge fluctuations in oil prices, as seen in early 2022 after Russia's invasion of Ukraine.

While the world is slowly moving away from fossil fuels towards renewable energy sources, this transition will take decades. Oil will remain an attractive investment option for those looking to invest in the overall health of the global economy, as many sectors, from transportation to petrochemicals, rely on it.

Therefore, investing in oil can be a wise decision, but it is important to carefully choose which oil stocks to buy and be aware of the risks involved.

Oil companies are crucial to the global economy

Oil companies play a pivotal role in extracting, refining, and selling oil and gas, which are essential resources for modern industry, transportation, and energy production. The products provided by oil companies power vehicles, planes, heating systems, and electricity generation. They are also used as raw materials for plastics, paints, chemicals, and more. As the world becomes increasingly interconnected through globalisation, the influence of oil companies extends across national borders, making them key players in international affairs and economics.

The largest oil companies, often referred to as 'Big Oil', are powerful multinational corporations with immense influence on global oil prices, policies, and supply chains. These companies include ExxonMobil, Royal Dutch Shell, and BP, which have diverse portfolios spanning from deep-sea drilling to renewable energy projects. The economic weight of these companies is significant, and their activities impact not just the energy sector but also broader industrial and financial systems.

Oil companies are major employers, creating numerous jobs directly and indirectly through their supply chains and associated industries. They invest heavily in infrastructure, research, and talent development, contributing to GDP growth and tax revenues. Additionally, they play a crucial role in ensuring the stability of energy supplies, which is vital for industrial productivity, utility services, and transportation systems.

In summary, oil companies are crucial to the global economy due to their role in providing essential resources, driving economic growth, employing millions, and influencing international affairs and economics. Their operations have far-reaching implications on global markets, trade flows, and energy security.

Oil stocks are highly volatile

The volatility of oil stocks can be attributed to various factors, including supply and demand imbalances, geopolitical events, and the actions of major oil-exporting nations. For instance, the COVID-19 pandemic caused a sharp decline in demand, leading to a crash in oil investments. On the other hand, Russia's invasion of Ukraine sent crude prices soaring.

The Organization of the Petroleum Exporting Countries (OPEC) also plays a crucial role in influencing oil prices. OPEC can withhold supply to push prices higher or increase output to drive them lower, causing massive fluctuations.

Additionally, oil stocks are sensitive to the cyclical nature of the industry. Oil demand generally tracks economic growth, and a robust economy can support rising oil prices. However, investing in oil stocks during a market rally can be risky, as it is challenging to time the market.

To manage the volatility of oil stocks, investors can consider the following strategies:

• Diversification: Invest in oil companies operating in multiple geographical regions or those that are vertically integrated, engaging in various activities.
• Strong financial profile: Look for companies with investment-grade bond ratings, ample cash reserves, and well-structured debt.
• Low costs of operations: Choose companies that can sustain operations at oil prices below $40 per barrel.
• Dividend income: Consider companies that offer stable and attractive dividend yields.

In conclusion, while oil stocks offer potential profits, investors should be cautious due to their volatile nature. It is essential to carefully consider the underlying factors driving the volatility and implement risk management strategies to make informed investment decisions.

Oil demand is increasing

The global demand for crude oil (including biofuels) in 2023 was 102.21 million barrels per day. This is expected to increase to more than 104 million barrels per day by the end of the year.

The Organization of the Petroleum Exporting Countries (OPEC) projects that global oil product demand will reach 110 million barrels per day by 2045, with transportation fuels such as gasoline and diesel expected to remain the most consumed products.

Diesel and gasoil demand is forecast to amount to 30.1 million barrels per day in 2045, up from 27.6 million barrels in 2021. Gasoline demand is also expected to increase, reaching 27.6 million barrels by 2045.

The increase in oil demand is driven by several factors, including:

• Population growth and higher quality of life around the world
• Increased demand from countries such as China, India, and the United States
• The need to replace depleted wells and old equipment
• Accommodating ever-higher standards and tighter regulations

Despite the growth in renewable energy sources, oil remains a key facet of the global economy and will continue to be so for years to come.

While electric vehicles are becoming more common, there will always be a demand for oil due to its use in plastics, trucks, and heavy equipment that require diesel.

The world is slowly moving away from fossil fuels in favour of green alternatives, but this transition will take decades. For the foreseeable future, oil will remain an attractive investment opportunity as it is still heavily relied upon for transportation, industry, and the creation of petrochemicals.

Oil investments can be tax-deductible

The US government has created a range of tax incentives for investors and small producers in the oil industry. These tax breaks are designed to stimulate domestic oil production and reduce the country's dependence on foreign imports.

Intangible Drilling Costs (IDCs)

Intangible drilling costs include expenses such as labour, fuel, chemicals, and hauling. IDCs typically make up 65-85% of the total cost of drilling a well and are 100% tax-deductible in the year they are incurred. This means that investors can deduct a significant portion of their investment from their taxable income, even if the well does not start drilling until the following year.

Tangible Drilling Costs (TDCs)

Tangible drilling costs refer to the direct cost of drilling equipment, such as casing, pump jacks, and wellheads. TDCs are also 100% deductible but must be depreciated over a 7-year period.

Lease Operating Expenses (LOEs)

Lease operating expenses cover the day-to-day costs of operating a well, including any costs of re-entry or re-work of an existing well. These expenses are generally deductible in the year they are incurred, without any Alternative Minimum Tax (AMT) consequences.

Depletion Allowance

The Small Producer's Tax Exemption, also known as the "depletion allowance," is a special tax advantage for small companies and investors. It allows 15% of all gross income from oil and gas wells to be exempt from taxation. This exemption is not available to large oil companies or those who own more than 1,000 barrels of oil per day.

Active vs Passive Income

The IRS specifies that a working interest in an oil and gas well is not a passive activity. This means that net losses from the well can be offset against other forms of income such as wages, interest, and capital gains.

Alternative Minimum Tax (AMT)

While excess IDCs may be subject to the AMT, percentage depletion is no longer considered a preference item. This means that small producers and investors can take advantage of the depletion allowance without worrying about AMT consequences.

Overall, oil investments offer significant tax advantages that can help reduce an investor's overall tax burden. These tax breaks are unique to the oil industry and can provide substantial benefits to those who invest directly in oil drilling and exploration.

Frequently asked questions