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How to invest in oil
4 ways to slip this valuable commodity into your portfolio.
For investors willing to take risks, falling prices offer the opportunity to grab low-priced stocks that may rise again in time. Oil prices, which are naturally cyclical, hit a historic low in early 2020.
If historical performance offers a lesson, however, it’s that oil is a volatile commodity whose value is driven by supply, political and environmental factors — and the demands of energy-driven nations. There’s no telling which direction the oil supply of other oil-producing countries will go, and the Middle East is no stranger to conflict and war that often disrupts the oil industry.
Each of the four investment options available for this commodity comes with risk, given you’re taking a bet as to how much oil will sell for.
1. Invest in oil ETFs.
Worth considering are exchange-traded funds (ETFs), which provide access to a variety of assets without putting all of your money into individual firms. Rather than buying a stock, you’re buying an oil ETF, which typically tracks the performance of several oil stocks.
Purchasing commodity-based oil ETFs is a direct method of owning oil. ETFs allow investors to minimize risk while taking advantage of the performance and general popularity of a particular sector. And oil ETF investors can avoid the risk of exposure to single stocks that fluctuate based on oil prices.
Oil ETFs can be a good choice for those who are new to investing or looking to secure their portfolio, and you have many oil-based ETFs to choose from, covering many companies in the industry. Here are some of the more popular options:
- US Oil Fund (USO): An ETF that directly tracks the price of oil through futures contracts on the benchmark West Texas Intermediate (WTI) crude oil.
- ProShares Ultra Bloomberg Crude Oil (UCO): A leveraged ETF that tracks the price of WTI crude oil and aims to double the daily price movements.
- SPDR S&P Oil & Gas Exploration & Production ETF (XOP): An ETF that tracks an index of the stocks of oil producers and explorers.
- VanEck Vectors Oil Services ETF (OIH): An ETF that tracks an index of the stocks of companies that provide support services to the oil producers and explorers.
If you’re considering a leveraged oil ETF like UCO, be careful. Leveraged ETFs are not designed to be bought and held for long periods of time; rather, they’re designed for short-term trades.
To achieve double or triple the returns of the futures or stocks they’re based on, these ETFs invest in options and derivatives that require a daily rebalancing of the ETF’s assets and target exposure. Therefore the asset base is constantly changing, and extreme volatility like the stock market experienced in March 2020 can erode the basis of your investment. In fact, the 2020 volatility forced some 3x leveraged oil ETFs to close temporarily or permanently.
- Instant diversification across the oil industry at a low price.
- Track record of providing safe and reliable growth.
- You relinquish some control over the split of assets.
- Leveraged ETFs are designed only for short-term trades, not buy and hold.
2. Invest in MLPs.
Existing primarily in the gas and oil industry, a master limited partnership (MLP) is a tax-advantaged corporate structure that combines the tax benefits of a partnership with the liquidity of a public company. Like a partnership, profits are taxed only when investors receive distributions.
MLPs typically own the pipelines that carry the commodity from one place to another, and they are known for paying high dividends, which makes them a popular option for investors who are seeking a long-term stream of income. MLPs are still volatile, though, and risks could come from a slowdown in energy demand, environmental hazards, commodity price fluctuations and tax law reform.
You’ll find MLPs listed in a brokerage account just like stocks and ETFs. Here are a few of the biggest ones:
- Offers an attractive dividend payment.
- Purchase easily through financial advisers or online brokers.
- Subject to general market risk and low energy demand.
- Stock prices aren’t necessarily in lockstep with the price of oil.
3. Invest in oil companies.
A simple way to invest in oil is by buying stocks of oil companies like:
- ExxonMobil (XOM)
- Chevron (CHV)
- Royal Dutch Shell (RDS.A or RDS.B)
- Total (TOT)
- British Petroleum (BP)
As the cost of oil changes, so do the values of these companies — although there’s no guarantee, given the factors they depend on.
In addition to the major oil companies, there are also companies that specialize in specific aspects of the industry. Here are a few examples:
- Refiners: Valero (VLO) and Marathon (MPC)
- Explorers: Cabot Oil & Gas (COG)
- Tanker fleet owners: Teekay (TK, TNK and TGP)
Understanding the energy cycle, the industry’s landscape and the impact of price fluctuations can help you determine valuable oil-related assets.
- Choose from a range of stocks, and cash out when you want.
- Access the market through an online broker or financial adviser.
- Large oil companies are involved in refining, which doesn’t benefit from higher oil prices, and so stocks aren’t necessarily in lockstep with the price of the commodity.
- Individual stocks can be more volatile than diversified ETFs.
4. Invest in oil futures.
Futures are the most direct way to purchase this commodity without literally purchasing barrels of oil, but they’re a more advanced and complex investment option that isn’t offered by the majority of brokerage accounts. You buy a futures contract through a commodities broker to purchase oil at a future date at a specified price. Purchases must take place before the contract expires.
Futures are extremely volatile and riskier than other investment options. You must be correct on the timing and price movement to see a profit. If you’re interested in futures, you’ll first have to choose a brokerage account that supports futures trading.
- Most actively traded future on the market — and the most liquid.
- Requires a specific brokerage platform that offers futures trading.
- Volatile investment without ability to predict with certainty how prices will fluctuate.
- If you fail to exercise your contract prior to its expiration, it’s worthless.
Compare these platforms to invest in oil
How much is oil worth today?
The graph below tracks the price per barrel of oil in US dollars over time.
What are the risks of investing in oil?
While long-term investments in oil companies can be highly profitable, understand the risk factors before making investments in the sector:
- Price volatility. Wide price fluctuations can occur daily due to unpredictable influences like supply and demand.
- Dividend cuts. If a company is unable to earn enough revenue to fund payments to investors, it may cut dividends.
- Oil spill risk. Accidents can cause a company’s share price to drop significantly. In 2010, BP saw a decline of more than 55% to its stock in the wake of the Deepwater Horizon oil spill.
You can get involved in oil through four main methods, each with its own set of risks. Before you buy, explore investment options for other tangible goods through multiple trading platforms.
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