Oil and Gas Investing 101

While we are still awaiting the Senate ruling on the “Big Beautiful Bill,” one major theme of the bill currently is a decreased emphasis on renewable energy sources, which can provide additional opportunities for oil & gas. However, international energy production may also be targeted, leaving U.S. production one of the most viable options for the coming years.

While we still don’t know how much time we have before renewables become more prevalent than oil & gas, the picture is already looking different compared to a year ago, when we covered the basics of Oil and Gas investing in our May 2024 webinar, which you can check out below.

The likely decrease in subsidies that benefit energy transition will make traditional energy sources more appealing. Of course, with drilling, production will go down over time, so repeat development is necessary to meet the current demands. This provides an opportunity for oil & gas investors.

Now’s the time for investors to act, before the production curve bends too far. While supply is declining, demand is also increasing. Here’s what you need to know about oil & gas investing, including the types, risks, and benefits.

Three Segments of Oil & Gas Investing

Three basic segments comprise oil & gas investing: upstream, midstream, and downstream.

Upstream Phase

In the upstream phase, oil and gas are found and extracted in the following stages:

• Exploration: During exploration, geologists and geophysicists use seismic surveys and other methods to locate potential oil and gas fields. You can think of this as an MRI of the ground where you can see the layers and where oil and gas may be trapped.
  
• Drilling: Once potential sites are identified through the imaging process, drilling rigs are used to bore wells to access the oil and gas.
  
• Production: Production involves extracting oil and gas from the wells using primary, secondary, and enhanced recovery techniques. These techniques are used based on the level of underground pressure available to push oil and gas to the surface. Secondary recovery includes techniques such as waterflooding. Enhanced oil recovery can involve gas injection, heat application (thermal recovery), and chemical injection to maximize oil flow.
  
• Well Services and Maintenance: To ensure continued production, this phase includes activities related to maintaining wells.

Midstream Phase

During midstream, oil & gas are transported from production sites to refineries.

Pipeline companies transport oil and gas from production sites to refineries using networks of pipelines. Companies in the midstream phase may also operate storage facilities for natural gas, refined products, and crude oil. Shipping companies work to transport oil and gas across oceans via tankers.

Here are the phases of midstream:

• Transportation: This is where oil and gas move from the production sites to refineries or storage facilities. Transport can be done through pipelines, tankers, trucks, or rail.
  
• Processing: Natural gas processing plants and facilities separate natural gas liquids (NGLs) from natural gas. These plants also handle impurity removal.
  
• Storage: Crude oil, natural gas, and refined products are stored at various stages of the production and distribution process.
  
• Distribution: Midstream moves to downstream in the distribution process. This is where oil and gas are distributed efficiently to refineries and other end users.

Downstream Phase

In the downstream phase, oil and gas are processed into usable products, including gasoline, diesel, and plastics.

This is the stage that reaches the consumer. Crude oil may be converted by refineries into gasoline, heating oil, diesel fuel, jet fuel, and other products. Natural gas liquids (NGLs) can also be used for fertilizers, plastics, and more. The consumer will experience this phase when they visit gas stations, airports, and other channels.

Downstream includes the following:

• Refining: In refining, crude oil is converted into various usable products, such as gasoline, diesel, jet fuel, heating oil, and petrochemicals.
• Marketing and Distribution: Refined products are then sold to consumers and businesses. This includes gas stations, retail outlets, and wholesale distributors.
• Petrochemicals: Petrochemicals are chemicals that are derived from petroleum and natural gas. These are used to make plastics, fertilizers, synthetic rubber, and other products.
• LNG Production: The liquefaction of natural gas is generally used for export purposes, but can be stored or transported.

Types of Oil and Gas Investments

Let’s look at the upstream stage more closely. In this phase, there are many different ways people can invest, which are categorized by green field and brown field opportunities. In general, you are either buying into the potential for oil or paying to extract more oil out of preexisting fields.

Green Field

With green field, you are exploring and finding new oil and gas. Sometimes this is already proven, but not yet produced. The degree of potential, uncertain, through realized also indicates the level of risk in the investment. When the potential is realized, the wells are producing and making money.

If green field investments are royalty-based, that means the investor owns a share of the land and gets a royalty from it. Lease rights are when an investor owns the land and gives it to someone else to get royalties on it.

Exploratory Drilling

While green field projects come with a fairly good likelihood of oil, exploratory drilling needs to happen to prove potential. Even with 60-70% certainty, oil can escape from the trap once it’s been drilled, so there are risks associated with exploratory drilling. However, costs are lower compared to other phases in millions of dollars.

Development and infrastructure

Once you’ve found a field and proven potential, it’s time to scale. This involves drilling more wells and building infrastructure to gather and process the oil before it is transported. The risks are much lower here, but the infrastructure costs are much greater compared to exploratory drilling – think hundreds of millions of dollars. The goal is to build and scale what’s already proven, so big corporations and government entities tend to take over in this stage.

Brown Field

Not all oil investments involve discovering new fields. Some focus on squeezing more value out of existing wells that are already producing oil. In a brown field acquisition, investors take over an established field or well and focus on optimizing production to extract more oil. While it can be less risky due to proven oil, it can also result in lower returns.

The risk level direction is opposite in this setup compared to a green field project. As you extract more oil, things become less risky.

A big focus in brown field acquisitions is on well maintenance and production optimization – improving and enhancing oil recovery using multiple technological interventions. This can look like pulling real-time data from where oil is extracted, building digital models, and managing the field:

• Where to inject
• Which wells to speed up and slow down
• Managing pipeline constraints

At this point, you want to maximize oil without drilling additional wells.

The final step involves shutting down the wells when no more oil can be extracted.

Where is the Opportunity for Investors?

There is a sweet spot in oil and gas investing that has been enabled by syndication and tax laws in the U.S. every day. Investors who explore a combination of geological studies, exploratory wells, and early field development can find rich opportunities in the upstream.

If you’re curious how oil & gas investing measures up to multifamily investing, you can learn more about the differences here.

Common Questions about Oil and Gas Investing

Here are some of the questions we tend to hear regarding oil and gas investing:

How much does it cost to drill a well?

It all depends, but for example, vertical wells that aren’t too deep can cost $2-3 million per well. Deeper wells can cost more, perhaps around $5 million. Horizontal wells also exist, where the drilling goes 90 degrees. These can cost $25-30 million per well.

Why invest now?

Even though there is a decreased supply in the U.S. and an energy transition is coming, oil & gas will still be relevant for the next 3-10 years. In addition to the delay in transitioning to renewables, we know that U.S. production will significantly drop in the next 5 years unless more wells are drilled.

What tax benefits are available with oil & gas?

You can deduct development expenses against active income, thanks to U.S. tax laws that treat oil & gas differently from most asset classes. This can be a significant advantage, especially for high-earning investors.

What are the risks and rewards of this type of deal?

The returns can be much higher for oil & gas investing compared to other forms of alternative investing, such as multifamily. For example, the reward can be 2-3 times greater in oil and gas compared to multifamily investing. However, with greater reward also comes greater risk. The level of risk depends on the project and phase, but a good upfront analysis can bring this risk down. There’s generally a 60-70% chance that drilling will result in producing oil, so drilling multiple wells can be another way you reduce risk.

What’s next for Investream?

We’re currently looking at some potential investment opportunities in oil & gas, particularly in previously overlooked areas. Bigger groups tend to chase other fields, so we’re looking at smaller projects somewhere in the 20-50 well development area.

Want early access to our next oil & gas opportunity? Join our investor list and be the first to know when projects open.