A Historical Overview Of Oil Investing


As early as 347 A.D., oil wells in China were up to 800 feet deep. Marco Polo saw seep oil mining as he traveled through Baku, Persia in 1264. In the 1500s, oil extracted from the Carpathian Mountains was used to power street lamps in Poland. In 1594, hand-dug oil wells up to 115 feet deep appeared in Baku. More than 140 years later, petroleum was extracted from oil sands at Pechelbronn field in Alsace, France.


gas pump

Born on July 8, 1839 in upstate New York, John D. Rockefeller set out to make $100,000 over the course of his lifetime. Despite being gifted in math and possessing many of the skills that would eventually make him wildly successful beyond even his own ambitious dreams, Rockefeller struggled to find work in Cleveland, OH after finishing a ten-week stint at Folsom’s Commercial College. He visited the locations that comprised Cleveland’s small business community as many as three times before he finally landed a job as an assistant bookkeeper with Hewitt & Tuttle, a commission merchant and produce shipping company, on September 26, 1855.


John Rockefeller

Similar to how prospective employers had no idea they were refusing work to the man who would eventually amass a fortune estimated to be nearly $500 billion in today’s dollarsat its peak when they turned Rockefeller away, people failed to recognized oil’s potential to change the world for many generations. Long before oil wells began to dot the American and global landscapes, prehistoric cultures used petroleum to benefit their societies. Rockefeller would later become a highly successful oil tycoon.


The Start of Oil Investing in the United States


By the early 1800s, salt was a valuable commodity in the United States. One way that people extracted salt from the earth was by evaporating the brine in salt springs, including the springs located in the Ohio River Valley. Salt wells were established near salt springs to make larger quantities of brine available for evaporation. A 58-foot salt well built by David and Joseph Ruffner in West Virginia in 1802 is believed to be among the first, if not the first, drilled well in America.


Depending on the location, salt wells produced more than brine. In western Virginia, Ohio and Kentucky, salt wells also produced natural gas and petroleum. Although the oil was widely considered a useless byproduct, a handful of salt producers saved the petroleum and sold it for medicinal purposes or for use as an illuminating agent.


While some people had already begun to realize the potential of oil, it wasn’t until 1853 that George Henry Bissell, who is widely considered to be the “Father of the Oil Industry,” began conducting experiments with rock oil from northwestern Pennsylvania. Using $526 of his own money, Bissell commissioned a study of the rock oil, which proved that the substance could be refined to produce kerosene. Two years later, Benjamin Silliman’s study, “Report on Rock Oil, or Petroleum, from Venango County, Pennsylvania,” suggested that oil could yield a considerable number of useful products. This assertion supported the notion that petroleum could evolve into a profitable commodity.


oil rig

Oil’s potential was only being realized in the United States as F.N. Semyenov, a Russian engineer, drilled the first modern oil well on the Aspheron Peninsula in Baku. Although General Andreas Pico produced oil from hand-dug wells to create lamp oil in Los Angeles, CA in 1850, North America did not have a drilled oil well until 1858, four years after the first European drilled oil wells appeared in Poland. The first drilled oil well in North America was created in Ontario, Canada.


A year later, Bissel’s company, Pennsylvania Rock Oil Company of New York, contracted Edwin L. Drake to drill for oil near an oil seep on Oil Creek close to the hillside town of Titusville, PA. Drake successfully used a drilling rig to create the nation’s first well that was to be used for the sole and specific purpose of producing oil. In other words, the oil produced by Drake’s well was not an inconvenient byproduct — it was the goal. This made Drake’s well the first commercial oil well in the United States.


At only 69 feet deep, Drake’s oil well produced 25 barrels of oil on its first day of operation in August of 1859. In a short period of time, Titusville was transformed from a quiet, scenic town along the Allegheny River into a bustling center of activity. The town’s population swelled from just 250 residents to 10,000 dwellers, and the price of real estate in the area increased dramatically. Jonathan Watson, the person who owned the land on which Drake drilled his commercial oil well, became the first millionaire in the country whose wealth was the direct result of oil production.


oil well

Drake's well did more than change Watson’s life and the man’s hometown of Titusville. The well inspired people from all walks of life to try to cash in on the production of oil by investing in the fledgling petroleum industry. While Drake’s well was not the first to be drilled in the world or on the North American continent, it was the first one to attract the interest of investors.


Just as the burgeoning oil industry created moneymaking opportunities in ancillary industries such as transportation and refining, it also gave people the chance to make money through investments in oil companies. By early 1861, an investment industry designed to solicit funds for the purpose of drilling oil wells began to evolve on the east coast of the United States.


The investment model was reasonably simple in theory. An oil well promoter would secure a land lease and then attempt to raise money to establish a commercial oil well on the property by petitioning funds from mostly wealthy prospective investors. At the time, investors tended to be hands-on and perform due diligence before they would agree to make an investment, particularly in a relatively unproven industry. Put simply, people were cautious about investing in oil companies, although some found promoters they believed would provide a return on their investment.


The Impact of the Civil War on Investment


In April of 1861, South Carolina was the first state to secede from the Union. Other southern states quickly followed suit in the buildup to the Civil War. Over the course of the years-long battle, the federal government spent more than $15 billion dollars to wage war against Confederate forces. In today’s dollars, that’s the equivalent of $300 billion.


cannon

The Union government wasn’t able to raise enough money to fight the Civil War through tariffs and imposts alone. Since the cash-strapped federal government needed money to continue paying Union soldiers and provide them with the supplies and armaments they needed to fight, it decided to raise $3 billion by selling bonds. In need of even more money, the government also printed nearly $1 billion in greenbacks. Paper greenbacks were currency that wasn’t backed by either gold or silver.


As the government used greenbacks to buy the things necessary to fight the south, the newly printed money made its way into the national economy. Some investors chose to invest their greenbacks in Drake’s well. This decision, along with the influx of $1 billion worth of unsecured greenbacks in the economy, created a sort of investment frenzy for the oil industry. Instead of getting involved in the companies they invested in as they historically had, investors started to trend toward investing in oil production outfits without even seeing them first.


Oil Production and Investment Spreads throughout USA


After the Drake well proved to be a success and with people willing to invest in drilled oil wells, commercial oil wells spread to other locations throughout the United States, including the Appalachian Basin, the Mid-continent, the Gulf Coast, the Rocky Mountains, California, North Dakota and Alaska. In 1860, America’s oil production was 500,000 barrels. A year later, this number had increased by more than 400 percent, up to 2.1 million barrels per year.


coins

The primary product that oil was used to make in the 19th century was kerosene. As a result, kerosene quickly replaced whale oil as the primary illuminating source used by Americans because it was easily accessible and more affordable than whale oil.


Charles Pratt’s business originally traded in whale oil, but Pratt became one of the pioneers of the natural oil industry in the United States when the demand for whale oil decreased. Pratt founded Astral Oil Works in Brooklyn, NY before he teamed up with Henry H. Rogers to create Charles Pratt and Company in 1867. Both of Pratt’s ventures became part of Standard Oil seven years later.


John D. Rockefeller founded Standard Oil of Ohio in 1870 with a $1 million investment. By constantly expanding and adding more oil refineries, Rockefeller grew Standard Oil into the largest, most powerful company in America and, many would argue, the world. By 1878, Standard Oil had become responsible for approximately 90 percent of the nation’s oil refining volume.


Even with business magnates such as Rockefeller, Pratt and Rogers at the forefront, the oil industry suffered its first recession in 1878, the year after the world’s first oil tanker, Zoroaster, was built to ship kerosene in the Caspian Sea. Thomas Edison invented the incandescent light bulb in 1878, which had a dramatic effect on the demand for kerosene and made the kerosene lamp obsolete over time. Since oil was primarily used to produce kerosene during this time, the oil industry suffered financially.


Standard Oil Co. logo

Despite this setback, innovations continued to be made in the industry and new uses for oil were identified. In 1896, the first offshore oil well was drilled off Summerland, CA, for instance. In 1903, Henry Ford incorporated the Ford Motor Company and five years later the company started mass producing the Model T automobile. The affordable Model T made it possible for an unprecedented number of Americans to own gas-powered vehicles, which had the added benefit of increasing consumer demand for gasoline. Up to this point, gasoline was predominantly a byproduct of the oil refining process that typically went unused.


In 1900, there were only 8,000 registered automobiles in the United States, more than 50 percent of which were sold that same year. A year later, nearly 15,000 gas-powered vehicles were registered in the country. Ten years later, more than 66,000 automobiles were registered in the United States, a figure which increased to 8.5 million by 1920.


Model T-Ford

While certain events such as the Great Depression, WWI, WWII, and the Middle East oil embargo have had both positive and negative effects on the global demand for oil over the years, the United States remained the world's top oil producer throughout much of the 19th and 20th centuries. Today, China is the biggest consumer of oil in the world, followed by the United States. Compared to 1900, the world produces 30 times more crude oil today than it did at the turn of the last century.


Investing in Oil Companies Today


In his book, "The Quest",oil analyst Daniel Yergin mentions that the world has extracted approximately one trillion barrels of oil from the ground since the 19th century. According to Yergin's book, at least five trillion more barrels of oil exist beneath the ground and more than 25 percent of that total is considered proved or certain in terms of its existence and accessibility. Given current and future plans, Yergin expects oil extraction throughout the world will increase around 20 percent between 2010 and 2030, increasing from 93 million barrels per day to an estimated 110 million barrels per day during that time period.


Yergin also points out that a person living in a developed country uses an average of 14 barrels of oil per year while an individual residing in another part of the world uses an average of just three barrels of oil annually. As underdeveloped countries become increasingly advanced, the demand for energy will grow in kind. Yergin estimates the increased demand alone will be greater than the total amount of energy that was consumed across the globe in 1970. Yergin attributes the expected increase in the demand for energy to a more robust world economy and a rising standard of living which will cause many millions of people to move away from impoverished areas.


oil barrels

With oil experts such as Yergin expecting the production of oil to increase and the global demand for oil to grow as more countries become increasingly advanced, now may be an optimal time to consider investing in oil companies. The first step to making successful investments in oil drilling is to understand the types of investments that are available in the petroleum industry.


If you are familiar with the stock market, then you probably already know that you can invest in the oil industry as a commodity of sorts. Several types of investment vehicles exist if you’re interested in doing this, including the following:


  • Mutual Funds
  • Large Cap Stocks
  • Futures Contracts
  • Small Cap Stocks
  • Limited Partnerships

There are several types of direct investments are available in the oil industry, include the following:


  • Exploration: Investing in exploration companies is highly speculative, and it typically appeals to investors who have a high tolerance for risk. Exploration projects involve buying or leasing land and drilling to see if it contains oil. There is no guarantee that an exploration project will be successful because it normally involves using wildcatting to search for oil. Wildcatting is an approach to exploration that involves looking for oil on land that has no known source for oil.
  • Development: Development involves drilling for oil close or next to an existing oil well or oil field. While this type of exploration is still speculative, the odds that a company will be successful at finding crude oil increase when this approach to finding oil is used instead of wildcatting.
  • Income: The goal of this type of project is to create a dependable stream of income that produces enough revenue to pay a company’s expenses and generate a profit. To do this, a company will either buy or lease land over a proven oil reserve. The biggest risk with this type of investment in the oil industry is that the reserve will be exhausted faster than expected.
  • Services & Support: Investing in a company that provides services or support to the petroleum industry is similar to investing in any other organization that provides business-to-business services or support in another industry. Many of these businesses don’t need the price of oil to increase to be profitable. It’s going to cost the same amount to transport oil through a pipeline no matter what the current price of oil is, for instance.

Investing in the oil industry offers several advantages. This type of investment can help to diversity your investment portfolio, for instance. When gas prices increase, national and regional economies are likely to slow down, but the value of oil and natural gas stocks usually rises. This means that investing in oil companies’ stocks can help protect the overall value of your portfolio when gas prices rise and economies slow down.


Investing in small oil producing companies or limited partnerships can also provide a seemingly endless upside. When successful, a single drilled oil well can have a yield that’s worth many times more than the money required to establish and operate the well, and the well may pay dividends for years to come.


tax advantages graph

Oil and gas investing experts agree that investing directly in an oil company also has several tax advantages, including the following:


  • Intangible Drilling Costs: Your intangible drilling costs include the things you need to drill for oil, such as labor, mud and chemicals, with the exception of your equipment. These expenses normally account for 65-80 percent of the amount it costs to drill a well and you can deduct 100 percent of them on your federal tax returns as long as your well is operating by March 31 of the following year.
  • Tangible Drilling Costs: These expenses are the direct costs related to your actual drilling equipment. You can deduct 100 percent of these expenses on your federal taxes, but you must do so over a seven-year period.
  • Small Producer Exemption: Small oil producers and their investors are eligible to take advantage of what’s commonly referred to as the “depletion allowance.” This exemption excludes 15 percent of a small oil producer’s gross income from taxation by the federal government. If a company produces or refines more than 50,000 barrels of oil per day or it owns more than 1,000 barrels of oil per day, the company cannot take advantage of the small producer tax exemption.
  • Lease Costs: You can deduct the amount you paid for your lease and mineral rights, your operating costs, and your administrative, legal and accounting expenses from your federal taxes. In order to do so, you must capitalize them and deduct them over the life of your lease.
  • Active Income: If you invest in an oil company or partnership directly instead of a stock, the Internal Revenue Service will consider your investment to be a working interest in the company instead of a royalty interest. This will help you if you lose money on your investment in a given year because you can use your losses to decrease the amount of your other taxable income on your federal tax return within designated limits. For instance, if you lose $1,000 on your investment in an oil company, you can offset the amount of your earned income or your capital gains by the same amount.

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If you want to learn more about investing in oil companies and the potential benefits it provides, contact our team of oil and gas investing experts. We're intimately familiar with oil and gas investing, and we’ll help you determine whether investing in the oil industry is the right financial move for you given your unique circumstances. If you decide to invest in the oil industry, we’ll explain how you should go about it and provide you with a set of helpful guidelines that will make the investment process even easier. Contact us today.

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