Are you looking for ways to invest in oil? Becoming an oil investor can bring many financial benefits when the market works out in your favor. However, oil, like any investment, can be a potential risk to your finances. Indeed, investing in oil is not for everyone.
In this article, I’ll cover some of the most popular ways to invest in oil. And not to worry, none of it involves holding barrels of oil in your basement!
Oil is not only the fuel that you put in your car. To be sure, it goes way beyond that. Understanding the oil market is tricky as it involves market cycles. And, it’s far more hectic than waiting at the gas station to fill your vehicle’s tank.
How to Invest in Oil: What to know
There are various ways via which you can invest in oil. And, none requires the purchase of oil to keep in your backyard. The most common ways that retail investors invest in oil is through oil stocks, mutual funds, and ETF’s. Additionally, there are more sophisticated ways to invest in oil.
Some of the common ways to invest in oil require a brokerage account.
Is it safe to invest in oil?
Any investment comes with some degree of risk. However, some investments are safer than others. Suppose you are thinking about investing in an oil fund. In that case, it is much safer to invest in a fund rather than a single company. Indeed, a fund gives the investor exposure to several companies, thereby reducing portfolio risk.
Related read: Best International ETF – Our Top 10 to Consider in 2021
How much money do I require to invest in oil?
Consumers looking to invest in oil need only buy one stock of an oil company. Interestingly with the advent of fractional shares, now investors can invest in oil with as little as $1. In other words, investing in oil is no longer just for the rich.
Uses of oil and petroleum
It’s common knowledge that oil that comes from the ground. And that product is known as crude oil. After it gets extracted from the ground, crude oil is processed and filtered to get used as various petroleum products. To be sure, oil and gas aren’t only for filling your car. According to the U.S. Energy Information Administration, oil gets used in many ways, including:
- Heating oil
- Lubricants
- Plastics
- Jet fuel
- Asphalt
- Waxes
What is the importance of petroleum supply?
The law of supply and demand is crucial for figuring out the actual worth of oil. Society depends on the need for oil for almost everything. However, consider that the market could change in the future as the world moves toward renewable energy.
Oil is a limited and non-renewable resource. And, one day or the other, we will run out of it.
Oil Stocks
Oil stocks are shares of companies that extract oil from the ground or those involved in producing a finished product (i.e., the gas you put in your car). Some companies do both. Naturally, it’s best to research the oil companies in which you look to invest. You might consider their balance sheet, the amount of debt they are carrying, and history of profitability. And, as they say: “Don’t keep all your eggs in one basket”. As a result, it’s usually a better idea to invest in oil mutual funds or ETFs as they give you diversification.
Pipeline companies are also a popular way to invest in oil. Pipeline companies earn money through the distribution of oil. So, to some degree, the cost of oil does not affect a pipeline companies’ bottom line. Instead, the quantity of the oil that gets delivered has a more profound effect. Having said that, if oil prices dropped 25% because of 25% less demand, the pipeline stock would almost certainly move lower.
Mutual Funds and ETF’s
Mutual funds have been available in their current state since 1924. The oldest mutual fund currently in existence is the Vanguard Wellington Fund Investor Shares (VWELX). However, the VWELX is not an oil mutual fund.
ETF’s, on the other hand, is a much newer product. The first U.S. ETF was the SPY, created by Nathan “Nate” Most in 1993. The SPY got designed to track the direction of the S&P 500. And to this day, it offers investors a way to invest in the S&P 500. Like mutual funds, ETF’s are a basket of stocks. However, they get traded in real-time, on the secondary market.
Mutual funds and ETFs based on oil offer investors a one-stop-shop to buy a basket of stocks. Indeed, they can quickly and easily diversify your portfolio.
However, regardless if you’re investing in oil ETFs or mutual funds, consider that you’d be investing in a single commodity. And the commodity is at risk. For example, if oil goes up in price, so will the individual stocks and funds – in almost all cases.
Oil Futures
Futures are much more complex instruments, often reserved for the producers, speculators, and investment bankers. Oil futures are contracts for 1000 barrels of oil. The oil futures contract buyer speculates that the price of oil will rise above the contract price at expiration. And, if it is, the futures contract will expire with value. The investor can then close out the contract by selling it back to the market at a profit.
Fun Fact: On April 20, 2020, the market value of oil prices fell to a negative number. Indeed, investors holding some futures contracts holders were paying buyers to take their contracts! Some buyers got as much as $37,630 for a single contract!
Direct Participation Programs
Suppose you are looking forward to a much direct way of investing in oil. In that case, you can consider DPP or direct participation. This method is for those who think about investing directly in the production or exploration of oil and gas.
DPP’s do not get traded on the secondary market. Rather, they are direct agreements between people and companies.
There are two significant advantages to investing in Oil DPP’s, namely:
- Cash flow
- Tax
When you invest in oil through DPP, you are purchasing a percentage of the oil operating company’s assets and interest. You get all the advantages of owning a portion of the business without actually getting involved in the operations.
With an oil DPP, it could be an option to secure steady, passive income.
Related Read: How to Generate Income From a Portfolio
Keep an Eye Out on the Oil Market
The primary factor determining the final oil price is the price per barrel of crude oil. Whenever there is an increase in crude oil price, the price of oil also goes up. Again, whenever there is a drop in crude oil price, the cost of oil and its products tends to drop. Famously, the price of oil plummeted during the COVID-19 pandemic.
The reason for such a drop is simple to understand: The cost of getting the oil out of the ground, refining it, storing it, and then distributing is nearly fixed. Whenever a barrel of crude oil can get sold at a much higher cost than all of these other costs, then the oil companies profit. But when the oil is trading for a lesser amount, the total cost eventually decreases, and the company tends to lose money.
And like all investing, the most successful investors buy low and sell high!
Final Words About Investing in Oil
For most investors looking to get into the oil market, the fundamentals are common. Those looking to learn how to invest in oil need to consider its current price, along with supply and demand. Then, ask themselves if they feel oil has a future. For me, I don’t invest in oil. Similarly, I don’t currently invest in energy. It’s not that I don’t want to. I just haven’t had a good enough buying opportunity.
Rick
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