Direct investing in oil and gas can provide an opportunity to cash in on high energy prices. The most conservative type of direct play is a fund that holds royalty interests. Such a fund provides investors with a specific portion of a property’s revenue stream without paying any operating or development costs.
Moving up the risk scale are income funds. They buy producing properties and sell the oil and gas, ideally over many years. In this type of investment, the key concerns are the extent of the properties’ reserves and future oil prices.
With income funds, investors are buying hard assets and will get some cash from future sales. The risk is that prices will fall from current levels. Still, acquisition and lifting costs are reasonable now so there’s room for profitability, even if prices drop a bit.
Some income funds are hedging the price risk by selling forward contracts on a percentage of future production. They’re reducing their use of leverage, too. If you’re considering an oil and gas income fund, find out whether the sponsor is pursuing such risk-reduction tactics.
