By Alex Rudner
Despite the initial allure, investing in oil and gas can be extremely risky for investors, especially those who are invested with smaller oil companies. Over the past few years, oil and gas prices have continued to dwindle as supply has exceeded demand. With oil prices low, some people may believe that now is the perfect time to buy, but proceed with caution, as oil investors have recently been burned.
Brokers often pitch and sell oil and gas investment contracts, such as limited partnership interests and general partnerships, to investors because they pay dividends and offer some tax benefits. However, these types of investments have proven to be risky because they are speculative and illiquid.
On top of those general risks, in the past few years the price of oil has dropped significantly. This drastic price decrease has led to the collapse of smaller companies that used financing from investors, resulting in huge losses.
Brokers are incentivized to sell these types of oil and gas investment contracts to investors because they receive big commissions for selling them. Thus, these brokers will often neglect their due diligence on the oil and gas investments and push these speculative and complex limited partnerships to unsophisticated investors who should not be placed in this type of investment.
A major reason for the decline in oil prices is the large supply of oil that is available. So much oil was drilled over the past decade that many companies could not make money by selling the oil. Due to the huge supply, some companies have shockingly drilled oil and then refused to unload it because they believed oil prices were too low. Eventually, these companies go bankrupt and the investments disappear, causing a total loss for investors. In fact, since the start of last year, 64 oil and gas companies have declared bankruptcy. Additionally, in the past year, the default rate among exploration and production junk bonds has risen to a record 27 percent.
Since the current price of oil is so low, some brokers will push it as a good investment, selling investors on the fact that the prices will rise. However, the oil market has proven to be volatile. Prices could continue to go down, and the emphasis on renewable energy has grown globally. Furthermore, investing solely on a low price does not account for supply and demand, in addition to other industry factors such as the location of wells and cash on hand. Be cautious if a broker recommends an oil investment as your investment tank could end up empty.