What is Oil Investing?
The term “Oil Investing” refers to the process of investing in oil or its other allied sectors through direct (in the form of a commodity) or indirect (in the form of energy related equity stocks, options & future contracts or exchange traded funds) investment methods. Basically, there are various options available for investors who intend to gain access to oil as an investment. However, each of these options have a unique combination of risk and reward.
Explanation of Oil Investing
Making an investment in oil and other related sector isn’t child’s playas the industry has a long history of volatility that has often resulted in sudden rise and fall in the value of the oil stocks. However, oil stocks have generated a massive amount of wealth for knowledgeable long term investors in the form of capital gains and dividends. Over the period of time, some of the greatest businessmen, such asJean Paul Getty, John D. Rockefeller, the Koch brothers, etc., have been able to muster the knowledge to understand the movement of this commodity and have made a great fortune through oil investing to become some of the wealthiest people in the history.
In the year 2014, oil prices plummeted in the year and the investors have experienced heavy losses during this period. After that, there was a stable period followed by another major dip again in 2020pushing it into the negative territory. But, more often than not, oil prices have managed to bounce back to reach new highs and the current oil crisis may be no different, which may be great opportunities for the investors.In fact, crude oil prices have already recovered to some extent to reach $43 per barrel in Aug 2020 after hitting rock bottom at $19 per barrel in April 2020(Source: Macrotrends).
How to Invest in Oil?
There are several ways to invest in oil and some of the most common avenues have been discussed below:
1. Direct Investment
- Oil Equity: In this method, investors can take exposure in oil companies by taking an equity position. This can either be done by purchasing equity stocks of oil companies on a stock exchange or by becoming part of a PE fund or hedge fund that offers equity position in companies engaged in the business of oil exploration or other related activities.
- Oil based Futures & Options: In this method, exposure in oil sector can be gained through the purchase of oil based futures &options. Typically, futures & options are highly volatile and so investors with a high-risk appetite should only go for this investment route. Further, investors should also have extensive knowledge of oil sector and a large amount of capital.
- Oil Based Exchange Traded Funds (ETFs): In this method, the investors purchase commodity-based oil ETFs, which are traded on the stock exchange. It is very similar to owing equity stock of oil based companies. The value of these funds usually move in tandem with the daily percentage change in the spot price of crude oil.
2. Indirect Investment
- Energy Sector ETFs& Mutual Funds: This is the only method of indirect investment in oil. In this method, investors can take exposure in oil by purchasing energy sector ETFs and mutual funds. These ETFs and mutual funds only invest in the stocks of oil based companies, that too at a lower risk.iShares Global Energy Sector Index Fund is an example of an energy sector ETF and T. Rowe Price New Era Fund is that of energy sector mutual fund.
Importance of Oil Investing
Oil as a resource have economic and strategic importance for many nations as it is still the primary source of a traditional form of energy. Some of the nations tend to maintain large reserves of crude oil for future use. The crude oil reserves are closely tracked by the investors because any change in the stock level is seen as a precursor of production and consumption trend.
There are still several decades of oil reserves available in the ground. Given the sustainable global demand driven by both developed and emerging markets, investment in oil could once again result in massive gains for the investors. So, it is important that investors still continue to invest in oil based companies despite the current down trends.
Some of the major advantages of Oil Investingare as follows:
- Investors can diversify their investment portfolio by investing in oil as it exhibits low correlation with most of the other assets. It can be a great technique in a volatile market.
- It offers has massive returns given the high level of risk associated with it.
- There are tax benefits for investors directly investing in it.
Some of the major disadvantages of Oil Investingare as follows:
- It exhibits very high volatility wherein the oil prices undergo significant fluctuations due to various factors, with demand and supply mismatch being the primary one.
- Only people with the knowledge of the oil market should invest as oil investing is a very complex trait given its dependency on multiple factors.
So, it can be seen that oil investing is a very complicated investment activity. It is true that it has the potential to generate exponential returns, but the high volatility of the sector indicates that only the seasoned investors with the proper knowledge should play this game. To summarize, investors can reap the benefits of oil investing only through proper due diligence and some sort of luck.
This is a guide to Oil Investing. Here we also discuss the introduction and how to invest in oil? along with advantages and disadvantages. You may also have a look at the following articles to learn more –