Investing in Oil Commodity Market and Tax Deductions
The importance of commodities is not limited to the everyday life of consumers. Investors use them to diversify their portfolios from conventional stock purchases, or to gain from frequent price movements. The staggering increase in the price of oil makes oil commodities a worthwhile area to invest.
Apart from the rise in prices, investors should also take note that the oil commodity market is moving towards renewable energy areas, implying a well-diversified market opportunity. Few months ago, a reform was introduced in the Senate for extending the tax benefits enjoyed by oil companies to clean energy projects, which opened up further opportunities for investors.
Understanding the Cost Structure of Oil Commodities
However, there’s a logic behind investing in oil commodities and it requires the understanding of the cost structure. Let’s take a look at some of the analysis done in recent times.
The big 5 oil companies in the U.S. (BP, Chevron, ConocoPhillips, ExxonMobil and Shell) managed $30.02 billion in the first quarter of this year. The cumulative tax break amounts to $2,400 million on an annual basis.
Estimates indicate that at any given time, the oil commodity market has 7 to 8 million barrels of oil. This is considered in the form of oil stocks which can be traded, bought and moved.
But when it comes to oil commodities, there are intangible and tangible costs related to each operation. For instance, every cost, apart from the actual drilling equipment’s for the drilling operation, makes up for the intangible costs. These costs are fully deductible in the year they are incurred.
“All for oil”. Watching the Esperanza begin the blockade by Greenpeace Esperanza, on Flickr. This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivs 3.0 Unported License.
With regards to the ‘drilling sector’, Ensco is an example of a good investment. The offshore drilling company has a net market cap of $13 billion and the current implied gain is about 17%. It specializes in drilling operations, which is the reason behind its success in the financial market.
On another level, Tidal Petroleum Inc. is a good example of an oil commodity that depicts the “oil transportation” industry. In the oil financial market, the company is a good model for diversification of investment. Tankers, pipelines and rail solutions all form one segment of oil based investment that can be used as a safety profit net against the volatility of the mainstream oil market.
Kind of Tax Benefits
Investing in oil also saves investors from spreading their investments since the commodity market offers diversity. While numerous benefits are enjoyed by the oil companies when investment takes place, the investors also get their fair share in the form of tax deductions.
Investment in the oil sector is also an incentive for the government to launch mining operations, and reward the investors with deductions.
Tax deductions are also offered on the gross revenues for oil depletion. In this category, two methods have been devised by the government. The first is the percentage deduction method, and the second is cost depletion method.
Percentage deduction, which is routinely used, allows the investor to have a 15% deduction from gross revenues. On the other hand, cost depletion is complex, but it has a significant deduction on the revenue.
Other areas where the tax deductions can be leveraged include lease operating cost, administrative cost and a cost of purchase of mineral and lease rights. Mineral rights can be cashed in by people and investors who have real estate in an area having oil or any other mineral of significance.
The booming economy of Texas is a well-established example of mineral rights and also the government based incentives for energy development in the area.
So if you choose oil commodities as an area of investment, you may just be in for the long haul with the right approach.
