It’s one of the most lucrative industries around and while there’s not an infinite supply of oil, it’s going to still remain that way for many years. However, investing in oil isn’t a no-brainer as some might lead you to expect.
For every positive Southlake Resources Group story, is a story about a separate company making a loss on a well. It’s not for the faint-hearted and in comparison to other industries, there is a huge amount of risk.
Of course, we’re not private consultants and we don’t have a list of all of the big risk factors for investing in this industry. We have put together some of the biggest reasons to look out for though and we’ll now take a look at them.
The mechanical risk
We don’t need to go into the ins and outs of well drilling but suffice to say, it’s not a simple practice. Drilling thousands of feet underground is far from straightforward and in most cases, hiccups will occur along the way.
Whether it’s drilling at slightly the wrong location, or installing poor quality steel casing, the list could go on. It could result in insufficient amounts of oil being extracted, or even the oil being extracted behind the casing and ultimately being lost.
Drilling a well successfully is a fine art and regardless of the project, this risk will always exist.
The people risk
Something that can possibly mitigate the above risk is the people who are involved in the project. If the people involved are experienced in the industry and honest, this risk factor is immediately diminished. If not, it immediately becomes a pressing problem.
Investing in the right oil operator is crucial. If they are experienced, it obviously increases the chances of success, but you’ve also got to consider the financial position of the operator and see just how they stand in relation to the project. Are they taking any risk on? If not, why not?
The commodity risk
Like a lot of industries, oil is hugely dependent on the market. In other words, while you may have initially forecasted to sell as ‘x’ per barrel, the market may have changed and resulted in the cost dropping considerably.
This is a commodity product and your price will reflect this. You have very little control over the price – which is why all of the things that you can manipulate are even more important.
The reserve risk
We’ve touched upon making sure that a well extracts sufficient quantities of oil – but only in the mechanical sense. In other words, what if the size of the reservoir you are using is just too small and has been massively overestimated?
This is one of the reasons why the initial evaluation period is so crucial. Sure, it’s not going to reveal the exact quantities of oil that will be extracted, but it can at least leave much less to chance.
The general rule of thumb is that a deal must be better than a 5 – 1 payoff although naturally, this can vary between investors.