What is the best way to invest in oil?
A complete guide to buying, selling and investing in oil.
Oil can be volatile. Its value is driven by supply, political and environmental factors, and the demand of energy-driven nations.
How to invest in oil
There are three main options for investing in oil:
1. Purchase oil company stocks
A simple way to invest in oil is through stocks of oil companies such as ExxonMobil (XOM) or Chevron (CHV). It is important to do your research into the production process and production potential. Developing an understanding of the energy cycle, the competitive landscape in the industry and the impact of price fluctuations will help you determine valuable 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.
- Due to the large businesses also being involved in things such as refining, which actually would not benefit from higher oil prices, oil company stocks don’t necessary move lock-step with the price of the commodity.
2. Purchase Oil ETFs
ETFs are another option worth considering. ETFs give access to a whole load of assets, without having to put all of your money into one or two firms. 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.
There are loads of oil-based ETFs to select from, covering a whole host of different companies within the industry. Oil ETFs can be a good choice for those who are new to investing, as well as those looking to secure their portfolio.
- ETFs allow for instant diversification across the whole oil industry, at a low price.
- ETFs have a better track record with providing safe, more reliable growth.
- By placing your money in an ETF, you relinquish some control over the split of assets.
3. Purchase Oil Futures
This is the most direct way to purchase the commodity without literally purchasing barrels of oil. Futures are purchased through a commodities broker. 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 the most actively traded future on the market and hence the most liquid.
- All futures are volatile investments and oil is no exception. No one can predict with any degree of certainty how the pice of oil will fluctuate.
- Futures expire on a certain date. If you fail to exercise them prior to expiry they become worthless.
3. Purchase MLP’s
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
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What are the risks?
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 is unable to earn enough revenue to fund payments to investors dividend 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 their stock in the wake of the Deepwater Horizon oil spill.
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