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Crude oil, also known as petroleum, is a liquid found on the Earth's surface. It consists primarily of hydrocarbons, organic compounds, and trace amounts of metal.
Every day, over 87 million barrels of crude oil and natural gas liquids are traded. This figure may rise in the future due to increased demand in developing countries with rapidly growing economies.
If you think that investing in oil is buying a couple of barrels and selling to the locals, then you should read this article carefully. Yes, you might become an oil tycoon but how much money is that going to cost? There are other ways to invest in black gold.
Is it a Good Time to Invest in Crude Oil?
Based on market projections, it seems crude oil prices are on the rise. The commodity shows signs of evergreen growth. Besides, it is one of the commodities with high demand in the manufacturing sector, especially in the motor industry. It also signifies economic prosperity and political muscle across the world.
You should note, though, investing in crude oil has its risks. Therefore, you must assess the market for potential volatility and openings, and evaluate your risk tolerance to determine your investment strategy (short- or long-term strategy).
Why Invest In Black Gold?
Before we list them, let's take a look at some of the reasons why you should invest in oil.
- Decreasing Oil Supplies – Oil supplies are decreasing. Oil is a non-renewable source of energy, so it means that over time the supplies will be exhausted. When you apply the simple rule of supply and demand, it's logical to conclude that prices will start increasing.
- Liquidity – Crude oil is the commodity which is most actively traded. In addition, oil stocks are also some of the most liquid assets out there. If you are already an investor, you know how key liquidity is when we talk about trading.
- Inflation Hedging – Commodities retain their value even in the event of inflation because they have intrinsic values that are independent of currency. Given the consistent and dependable global demand for crude oil, it can be a great hedge against inflation.
- Diversity – Investing in oil gives you the opportunity to diversify your portfolio and hedge your investments for future changes in market enviroment.
What Are The Risks?
However, oil stock investments are risker than other stock market sectors because the industry has several additional risk factors, including:
- Uncertainty: Oil and gas exploration is a risky business. A company purchases the rights to an exploration block and conducts tests to determine the presence or absence of oil or gas deposits. If they are discovered, the company will drill test wells to determine the quality of the deposits before drilling production wells and connecting the associated infrastructure, all before making any money. Because of the inherent uncertainty of exploration, large losses can result from investments that do not pan out.
- Volatility: Other factors beyond the control of oil and gas companies. Oil and gas prices play a significant role in the valuations of oil and gas stocks. The market tends to punish these stocks when prices are low. When Saudi Arabia and Russia launched an oil price war in March 2020, causing global oil prices to plummet, stock prices in the oil and gas sector plummeted as well.
- Cyclicality: The oil and gas industry is cyclical, which means that investors can expect booms and busts.
- Environmental concerns: The production, transportation, and combustion of fossil fuels emit greenhouse gases, which contribute to climate change. As a result, governments are putting increasing pressure on businesses to decarbonize their operations. As a result, demand for oil and gas is expected to fall in the coming decades.
How Much Money do I Need?
Generally, how much you can invest in oil is closely correlated to the amount of money you have at hand and how much you are willing to risk. Also, you will have to consider brokerage minimum investment limits and the type of investment.
For instance, investing in EFTs will not be the same as investing in individual barrels. Similarly, investing in shares of an oil company will be dictated by the per-share price and other imposed limitations.
The Most Popular Ways To Invest In Oil
Now you know some of the reasons to invest in black gold. Which are the most common ways to do so?
Buy Oil Stocks
Similar to gold investment, one of the best ways to invest in oil is to buy shares of companies that produce the commodity. Again, it's a very simple and easy method to participate.
Companies pay their shareholders dividends. So, you can have a nice profit out of your oil stocks. While waiting for oil prices to go up, you can easily enjoy the dividends these companies pay. Even though there is a strong correlation between the price of crude oil and oil companies shares, things might be a little different.
Big companies and business do so many things that crude oil price is just one part of the whole process. You have to follow the company's overall performance as well as oil price. Some of the companies you might consider investing in are Exxon-Mobile, British Petroleum Plc, Chevron Corporation, Royal Dutch Shell Plc. and many more.
How to Buy Oil Stock?
Investing in oil stocks is like buying company stocks, only that you are investing in an oil production company. As a result, to make the right investment choices, consider the following.
First, watch on oil prices. Learn how to track the performance of a stock. Mostly, compare the cost per barrel across multiple oil companies. With the above, you will have a sense of when to invest in oil stocks. High volatility will mean an unstable market, which makes the investment questionable.
Another consideration is the dividends cut. Factors like world economic status and political health affect crude oil stocks, which impact profits and dividends. Lastly, learn about different oil stocks in the industry. Some examples are downstream oil companies, oilfield service companies, oil EFTs, midstream companies, etc.
Invest In Oil EFTs
Exchange traded funds (ETF) are very similar to index mutual funds and offer one of the most accessible and affordable options. You can easily purchase shares of ETFs and join the game. This is a very quick and simple way to become part of this dynamic industry.
Buying oil ETFs gives you exposure to the market without directly holding the actual barrels of oil. It is, essentially, an index tracking the oil industry, which means you will not be investing in a single stock. Instead, it is a consolidation of different stocks within the oil industry. These funds offer their investors the chance to own oil stocks, futures and derivatives. Hence, it reduces risks by diversification. Unlike buying oil futures, EFTs are simple to set up, since buying and selling oil ETFs is similar to traditional stocks. In addition, ETFs are cost-efficient, since they do not attract high management fees.
Purchase Oil Futures
If you don't want to literally buy barrels of oil, you can purchase some oil futures. These are contracts between you as an investor and a broker, to sell or buy the commodity. How It Works?
Companies use futures to lock in a favorable price for oil and to hedge against price fluctuations. They are popular among speculative traders as well because there is no need to take delivery of barrels of oil – although you must fulfill the contract, this can be done through cash settlement.
In theory, oil futures contracts are straightforward. In this agreement, the price and the date of the deal in the future are set in advance. They continue the time-honored practice of certain market participants selling risk to others who gladly buy it in the hope of profit. To put it another way, buyers and sellers agree on a price at which oil will trade not today, but on some future date. While no one knows what price oil will be trading at in nine months, futures market participants believe they can.
Since the price of oil is extremely volatile, the leverage is really high – something between 5-10%. However, it could mean both profit or loss. So, it's a double-edged sword.
Usually, futures contracts require a profound knowledge of the financial sector so they are not recommended to newbies.
Invest In Oil MLPs
This is yet another way to take advantage of investment in black gold. Unlike investing in EFTs, this is a long-term investment strategy.
MLP stands for master limited partnership and these companies have two types of shareholders: general partners and limited partners (investors).The former are the people who run the business and the latter are the investors who purchase company shares.
These companies can come up with some attractive dividends and potential for capital gains.
Own Crude Oil
This is the most inefficient and expensive way to invest in oil. Owning crude oil is no easy task since it's time- and money-consuming. You need to store it somewhere under special conditions.
Besides, you have to invest in suitable facilities and equipment needed for the process. And given these inconsistent prices – it's very, very risky. When you have the other four options, this one almost looks like a joke.
Is Investing in Oil Safe?
Investing in oil has some degree of risk. Mostly, the level of risks depends on your investment option. For instance, investing in an oil fund can be relatively safer than investing in a single oil company. This is possible because mutual funds pull together stocks to reduce risks, a process known as diversification. This is the same case with trading oil CFDs or oil EFTs.
While CFDs leverage seem lucrative when you make profits, they can be extremely risky as they magnify losses. In contrast, investing in Oil EFTs is a diversification strategy offering you the same experience as buying stocks minus the risk factor of investing in a single stock.
Whatever we say about oil, it won't be enough. When you look around, you can see that it is virtually everywhere.
Why not invest in it and take advantage of the future of the energy sector?
Besides physically buying oil, you can invest in this commodity effectively and efficiently in different ways. They include investment in oil EFTs, buying shares, investing in oil futures and MLPs. Each one of them has their benefits and downsides. You are the one to make the final decision.
The Smart Investor content is intended to be used and must be used for informational purposes only. We are not an investment advisor and you should NOT rely on this information to make investment decisions .
One of the options available is to trade Oil CFDs. These are contracts that allow you to use broker leverage. For example, if the leverage is 1:10 ratio, for every of your dollar, you will have a $10 investment.
Another option is to trade oil ETFs. In this case, you will be trading under the commodity section with oil as your choice.
You can also trade oil futures. The option allows you to buy oil contracts without necessarily owning oil barrels.
In addition, you can trade in oil MLPs. By investing in Master Limited Partnership, you became one of the limited shareholders receiving its share dividends on profit.
One more option worth considering is investing in oil shares. Here, you invest in companies that are in the business of oil production.
In a precise answer, yes. Crude oil is one of the investment options that provide unique opportunities. In a global scope, it affects how world economies and political systems are performing. Its industrial usage is extremely high, and products that rely on oil on a world scale are uncountable.
Based on market forecasts projecting oil prices, the commodity prices per barrel will continue to rise. In 2021 it traded at $70 – $74, while in 2030, projections show it will hit $92, and by 2050 it will likely trade at $107.
The answer is yes, but it would be difficult to find an investment with extremely low risk or with no risk. This is because different investments pose different levels of risks.
As a result, none can fully guarantee a return or fully satisfy your investment returns desire. If you have good trading skills, you can analyze investments to handpick investments with the lowest risk at their current state. You also need to understand your investment strategy to find stocks that fit your risk profile.