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How to invest in oil
Investing in oil is simpler than you might think, this guide explains the best ways to do it.
Stock markets have been volatile in 2020. Following the impact of coronavirus, a further market meltdown took place on Monday 9th March, triggered by a dispute between major oil exporters Russia and Saudi Arabia over oil production levels.
Russia had turned down an offer by oil-exporting group OPEC to cut supply to cope with dropping demand. In response, Saudi Arabia said it would pump more oil (and in so doing cut prices further). This exchange sparked fears of a price war.
For some investors, falling prices are an opportunity. For those willing to take the risks, there is the potential to grab discounted oil stocks that are still good value – and will ideally rise.
As the current climate shows, oil can be very volatile. Its value is driven by supply, political and environmental factors, plus the demand from high-energy-driven nations.
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Invest in oil company stocks
A simple way to invest in oil is through stocks of oil companies such as BHP (BHP) or Oil Search (OSH). Generally speaking, as the cost of oil changes, so will the value of these companies – although this isn’t guaranteed and depends on many factors.
Developing an understanding of the energy cycle, the landscape in the industry and the impact of price fluctuations helps you determine valuable oil-related assets.
Accessing the market this way is simple because shares can be purchased with an online broker or financial advisor.
- You can pick and choose a range of stocks and cash out when you want.
- A simple, accessible and versatile way to access the market.
- Large businesses are involved in things such as refining, which don’t actually benefit from higher oil prices, so oil company stocks don’t necessarily move lock-step with the price of the commodity.
- Oil stocks are regarded as being more volatile, than other sectors.
Invest in oil ETFs
ETFs are another option worth considering. ETFs, give access to a whole range of assets, without having to put all of your money into individual firms. The process is pretty much the same as buying stocks, but instead, you’re buying an oil “ETF”, which typically tracks the performance of oil stocks.
If you need to brush up on ETFs, check out our guide.
Purchasing commodity-based oil ETFs is a direct method of owning oil. ETFs can be purchased and sold in a manner similar to stocks. They allow investors to minimise risk while taking advantage of the performance and general popularity of a particular sector. Oil ETF investors can avoid the risk of exposure to single stocks that fluctuate based oil prices.
- ETFs allow for instant diversification across the oil industry, at a low price.
- ETFs have a better track record for providing safe, more reliable growth.
- By placing your money in an ETF, you relinquish some control over the split of assets.
Invest in oil futures
This is the most direct way to purchase the commodity without literally purchasing barrels of oil. In New Zealand, futures are purchased through a commodities CFD broker – which are available online. You are buying a contract to purchase oil at a future date at a specified price.
Futures are extremely volatile and riskier than other investment options. You have to be right on the timing and price movement.
- Oil futures are among the most actively-traded future on the market and hence among the most liquid.
- All futures are volatile investments and oil is no exception. No one can predict with any degree of certainty how the price of oil will fluctuate.
- Futures expire on a specific date. If you fail to exercise them prior to expiry they become worthless.
Invest in MLPs
Primarily existing in the gas and oil industry, A Master Limited Partnership (MLP) is a tax-advantaged corporate structure. It combines the tax benefits of a partnership – profits are taxed only when investors actually receive distributions – with the liquidity of a public company.
Typically, these companies own the pipelines that carry the commodity from one place to another.
Risks to MLPs could come from a slowdown in energy demand, environmental hazards, commodity price fluctuations, and tax law reform.
- Companies can offer a very attractive dividend payment.
- MLPs can easily be purchased through financial advisors or online brokers.
- MLPs are subject to general market risk and low energy demand.
- Stock prices don’t necessary move lock-step with the price of oil
What are the risks of investing in oil?
While long-term investments in oil companies can be highly profitable, investors should understand the risk factors before making investments in the sector. These risks include:
- Price volatility: Large price fluctuations can occur daily, due to unpredictable influences such as supply and demand.
- Dividend cuts: If a company can’t earn enough revenue to fund payments to investors, dividends can be cut.
- Oil spill risk: Accidents, such as oil spills, can cause a company’s share price to drop significantly. In 2010, BP saw a decline of over 55% to its stock in the wake of the Deepwater Horizon oil spill.
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