MISCONCEPTION #1 – I can make a better profit by buying stock in Exxon or another major oil company from my stock broker than I can by investing directly in an oil well.

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FACT – Buying shares of a company’s stock from your stockbroker is essentially buying a tiny piece of a large corporation that has millions of different pieces.  While it may put your mind at ease that major oil companies often have operations around the world that grow their business, these companies also have substantial expenses, which means they have to see substantial market movement for you to make a large profit.  When you invest directly into one well or a group of wells, you invest in the process of drilling and production rather than investing in running a huge corporation.  Your investment will have the opportunity to grow faster and larger when it is focused on a specific project.

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MISCONCEPTION #2 – By investing directly in an oil or natural gas well, I can lose all of my money.

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FACT – Investing in oil and natural gas wells has its risks, but let’s look at how your money works for you.  When you invest in the stock market or in real estate, you are typically investing with post-tax dollars, or money on which you have already paid taxes.  However, when you invest directly in an oil or natural gas well, you receive tax deductions against ordinary income for intangible and tangible drilling costs.  For example, if you invested $100,000 in the drilling of a well, you would be able to deduct 60 to 85% of the investment in the year the well was drilled, and the remainder over the next five years.  Rather than sending 35 to 40% of the income you’ve invested to the government in taxes, it’s more like you’ve invested some of your money and some of the government’s money to go to work for you.

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MISCONCEPTION #3 – If someone offers me an opportunity to invest directly in an oil well, it has to be a scam.

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FACT – The best way to learn more about any investment opportunity is to do your due diligence.  If you have an investment representative that handles your investments, he or she has done due diligence on you and researched the investment products where he or she will invest your money to best match your investment objectives and risk tolerance.  With a direct investment in an oil well, it’s the same process – do your research.  If possible, visit the drilling site and speak with the technical staff involved with the project.  Ask questions and be a well-informed investor.

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MISCONCEPTION #4 – Only about one in 10 wells drilled find oil; most wells are dry holes.

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FACT – Stories abound of folks going from rags to riches on a middle-of-nowhere “wildcatter” or accidentally discovering oil and living happily ever after like the Beverly Hillbillies.  In reality, this does not happen often and exploratory, or wildcat, drilling in areas not known to have oil and natural gas production have a high yield for dry holes.  However, developmental drilling, or drilling near known or existing production, especially when coupled with new technologies that help to better locate and extract oil and natural gas, often has a much higher success rate.

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MISCONCEPTION #5 – If I invest directly in an oil well, I will be stuck with it forever and will not be able to sell my interest.

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FACT – Although there may be certain restrictions to sale depending on an investment’s structure, interest in wells can be valued and sold based on their cash flow.  The longer you own an oil well, the better established its production history and proven cash flow record will be, making your interest in the well easier to sell.  Industry interest in a particular oil and natural gas field or region may also provide selling opportunities.  However, if your investment in an oil well is producing steady income, you may want to hold onto it for its long-term value.

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MISCONCEPTION #6 – Drilling oil wells sounds dangerous and carries a lot of liability; I don’t want to be a part of that liability factor.

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FACT – The process of drilling an oil well has its dangers, but professional drilling crews are well trained and have regular safety meetings to help minimize operational risks.  Furthermore, operators, drilling companies and others involved in the drilling process often carry multiple millions of dollars of insurance coverage for hazards.  If you invest in a well that is being drilled under a turnkey agreement, your cost of drilling the well is limited to the amount of your investment.  As a direct investor in an oil well, you are still liable for certain costs, including lease operating expenses.

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MISCONCEPTION #7 – If I invest in an oil well, it is not going to have a very long lifespan.

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FACT – Oil and natural gas are naturally depleting resources.  But while it is true that there may only be limited reserves in any productive field and every well will eventually stop producing, it does not mean that a well will have a short lifespan.  Oil wells will typically experience their highest rates of production early in their lifecycle.  This is often due to the wells flowing on the pressure that has been trapped in the earth for millions of years.  Much like air escaping a punctured tire, the initial high pressure in a well will eventually dissipate, along with the oil and gas that can be produced, but this may take many years or decades.  Once a well cannot flow on its own pressure, artificial pressure can be used to continue—and sometimes increase—the production of a well for decades.  An investment you make in a well has the potential to be passed down in your family for generations.

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MISCONCEPTION #8 – I know that the only reason I am asked to invest in an oil well is because they know it isn’t going to be a good well.

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FACT – Each and every oil well is different, and nobody knows how an oil well will perform before it has been drilled—that’s just part of the normal risk of drilling a well.  Developmental drilling, or drilling in an area with known oil production, can give you an idea of the potential of a new well, but even then it’s not a certainty.  Because of the “unknown” in oil well drilling, oil companies often share the wealth and the risk when drilling new projects.  As oil companies know, not every well is going to be a gusher, and not every well will be a dry hole, but it’s better to own a piece of a lot of wells and spread your risk/reward potential than to have all your eggs in one basket.