How to Invest in Oil: What You Need to Know

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Updated on Monday, June 22, 2020

From mutual funds to master limited partnerships, there are a number of ways to invest in oil, and potentially make money while diversifying your portfolio. Oil is one of the most popular commodities in the world. But while chances are you know the cost of oil impacts the price you pay at the gas pump, what if you could take a more direct approach to profiting from oil? Read our review to learn everything you need to know about investing in oil.

4 ways to invest in oil

Invest in an oil ETF or mutual fund

Among the easiest ways to invest in oil is through an oil exchange-traded fund (ETF) or mutual fund. Funds offer exposure to a variety of investments at once, and an oil ETF or mutual fund focuses on companies and other assets that are connected to oil. This might include ETFs and funds that focus on exploration, production and delivery — and everything in between.

With a mutual fund, you get instant diversity and own a piece of each company in the mutual fund. With an oil ETF, on the other hand, you might be exposed to other assets, such as a collection of oil futures. You might even be able to invest in a short oil ETF that assumes that oil prices will fall, or a crude oil ETF that focuses more on how various wells and related concerns are performing. Realize, though, that an ETF doesn’t invest directly in the underlying assets.

Funds can be the simplest choices, since there’s a good chance you already understand how a mutual fund works, and ETFs are traded like stocks on the market. For those interested in long-term investing, and want a simple way to gain exposure to the oil market and add a little more diversity to the portfolio, oil ETFs and mutual funds can be one way to make it work.

Invest in crude oil futures and options

You can also invest in oil by focusing on oil futures and options. Investing in crude oil futures or heating oil futures can provide you with a more direct way to invest in oil.

When you use futures or options, you’re essentially betting on how the price will fare, or you’re taking the opportunity to get access to oil at a lower price in the hopes you’ll be able to sell it later at a higher one. With options, there’s also the ability to short oil prices and come out ahead if the oil price drops.

In either case, though, it’s important to take extra time to learn about what you’re doing and make sure you fully understand the risks involved. Learn how to read an oil futures chart and follow crude oil futures news. The way you trade futures and options is different from using the stock market or a mutual fund, so you need to understand the platform. Successful oil futures traders spend a lot of time learning and following trends and news, whether they specialize in West Texas Intermediate (WTI) or Brent crude.

If you’re approved through your brokerage to trade oil futures or options, though, you can trade on margin, using leverage to multiply your position, and magnify your gains. But watch out — leverage can also magnify your losses, so it’s important to only risk money you can afford to lose.

Invest in oil stocks

Another way to experience a little more direct investment in oil is to focus on oil stocks. If you want to own individual stocks, rather than funds, you can learn how to invest in oil stocks fairly easily.

With the right expertise, you can identify the companies likely to be the biggest winners in the industry while avoiding some of the less-profitable ones. This can be an advantage because oil company profits are tied to the price of oil. As the price of oil rises, company profits go up.

Big oil companies are called supermajors, and they integrate different businesses up and down the supply chain, from those that extract the oil from wells or oil sands to those that process it to make various oil-based products, including gasoline. When the economy is doing well and demand for oil is up, these supermajors — think ExxonMobile (XOM) or Chevron (CVX) — generally do well. They are also major blue chip oil stocks. However, with a little digging, you can find success with smaller oil companies as well.

Invest in oil master-limited partnerships (MLPs)

A master-limited partnership (MLP) is a type of business that trades publicly on an exchange like a stock. Usually, these partnerships are designed to provide growth to investors by holding properties like pipelines, oil exploration sites and other resource-related assets.

In general, MLPs can make cash payouts — which is why they can be so popular with investors. However, it’s important to note that the partnership nature of an MLP means it has different tax considerations than what you’d see with more traditional stocks. Before investing in an MLP, consider consulting with a tax professional.

Understanding oil market fundamentals

In addition to knowing how companies fit into the supply chain, it’s also helpful to understand oil market fundamentals. Here are some of the things to keep in mind as you learn about the oil market and as you put together your own investing plan.

Oil market supply and demand

One of the basic principles of our economic system is that of supply and demand. Understanding this in the oil market is essential to success as an oil investor.

In general, economic growth tends to lead to greater demand in the market. As demand grows, the price of oil increases, and this increase in price brings greater revenues to companies involved in the oil supply chain. Indeed, even the anticipation of increased demand — such as in the months leading up to the summer travel season starting Memorial Day weekend — can lead to a bump in prices.

Supply also plays its part. When supply increases, it can actually lead to a decrease in price. If there’s more oil on the market than is needed by demand, prices have to drop in order to encourage others to buy the excess supply.

On the flip side, supply disruptions can boost prices. A war in a key oil production area, or an event that interrupts the pipeline, can reduce the availability of oil on the market. When oil can’t make it to market, its presumed scarcity drives prices up. With supply unable to meet demand, those willing to pay more get access to the resource.

As an oil investor, you’ll need to be aware of the forces that can impact oil market supply and demand and take them into account when making your oil investing choices. Some additional factors to keep in mind include:

  • Geopolitics: Trade deals can impact supply and demand. Additionally, situations that can affect a major country’s economy can also create changes to oil prices. If a major oil buyer like the U.S. or China experiences an economic disruption, demand can drop — and so can oil prices.
  • Currency: It’s important to note that oil prices are expressed in U.S. dollars. So, if oil prices rise, it can cause a problem in countries that don’t use the dollar or that have currencies that are relatively weak in comparison to the dollar. On the other hand, if the dollar weakens relative to other currencies, it can make oil cheaper in those countries.
  • Speculation: Don’t forget about speculation. If investors feel like they should buy at a certain time, or make decisions based on what they think will happen, it can spill over into real impacts on the oil market.

How OPEC impacts oil investing

One of the biggest influences in the global oil market is the Organization of Petroleum Exporting Countries (OPEC). This 14-member association exists mainly to control the production of oil in a way that maximizes member profits.

OPEC is mainly concerned with controlling production in a way that keeps oil prices at a supportive level. However, it’s important to note that the members of OPEC also recognize that prices that get too high might prompt more investment in alternative energy sources — so the idea is to keep oil prices in a sweet spot that provides profitability, but also doesn’t push consumers and countries to develop alternatives to oil.

Sometimes, though, OPEC members don’t always agree on a course of action. In early 2020, for example, members Russia and Saudi Arabia had a disagreement over production, causing more oil to flood the market and prices to drop precipitously. This disagreement happened at a time of decreasing demand, due to stay-at-home orders issued in response to the COVID-19 pandemic, which further complicated matters and impacted crude oil prices.

Upstream, midstream and downstream oil companies

When learning how to invest in oil, it’s also important to understand the differences between upstream, midstream and downstream oil companies and how they operate. These companies are all part of the oil supply chain and knowing what they do can help you make more informed decisions about how to invest in oil.

  • Upstream: This is the beginning of the oil supply chain. These are companies that focus on exploration and production, and the activities involved include geologic surveys to find oil, drilling and the extraction of oil from wells or oil sands.
  • Midstream: Midstream oil companies (often MLPs) are usually connected to the transportation and storage of crude oil. Often, these actions involve using pipelines, tanker trucks and rail cars to move and store oil.
  • Downstream: Companies involved in downstream operations are related to turning crude oil into the products that consumers use regularly. Fuel, asphalt, heating oil and more are all part of downstream companies.

How to get started with investing in oil

You might be surprised at how easy it is to invest in oil. You can decide how you want to make your investing decisions: choosing a less risky mode of investment, such as oil ETFs and mutual funds or the individual stocks of supermajors, or taking a little more risk with oil futures and options or MLPs.

Investors looking to participate in oil must carefully consider what they’re looking for:

  • If you’re looking for long-term gains, investing in the stocks of well-run oil-producing companies or funds holding those companies can create attractive long-term gains. Some of the market’s largest businesses — Exxon Mobil and Chevron — are oil companies, and so are some of the market’s highest dividend payers.
  • If you’re looking for short-term trading profits, oil futures and funds owning oil directly will be what you’ll turn to. While the price of oil may go up over time, it doesn’t create the kind of buy-and-hold returns you can earn with companies. Instead, the price fluctuates a lot, meaning you’ll need to trade your way to wealth.

You can invest either directly through a broker or open an online brokerage account.

Regardless of which route you take to start investing in oil, it’s imperative that you do your research ahead of time and understand the risks involved. You should also make sure that oil investing fits with your overall goals, as well as adds to your portfolio, before you get started.

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