Out of all the commodities out there, few are as important as oil. It’s no exaggeration that the world relies on oil. From the auto industry to grocery stores and just about everything in between, oil is what keeps things running. Beyond transportation, oil is needed for manufacturing – particularly plastic – generating electricity and much more.
Oil, with its plethora of uses, is a crucial aspect of the global economy that will be in demand for the foreseeable future. There are a number of different ways oil can be invested in. Diversity is an important part of any investment portfolio, and oil in all its forms provides exactly that to interested investors.
Here are the basics about investing in the oil industry:
The simplest way to get exposure to the oil industry is through index funds. These ETFs and mutual funds consist of numerous oil-related companies. By going this route, you’re not putting all your eggs in one basket and investing in a single company. Instead, you’re investing in the bigger players in the oil industry.
Investing in index funds lessens the volatility that comes from owning a single company. A single scandal or accident can hit a company especially hard, so spreading the risk to the rest of the industry is a smart move. When the entire industry is faring well, you’ll see the value in your investment rise.
While the funds offered by financial institutions are quite similar, they’re not all alike. Do some research to find out what the best funds are.
Large or Small Cap Stocks
If you’re willing to do the research, then investing directly in a company can provide you with a better return and fewer fees than investing in a fund. Buying shares in large cap companies like Exxon Mobil or small caps or Alon USA Energy give you access to the oil industry without having to buy any oil.
While index funds are the way to go for most investors, investing directly in a company is a prudent move if you’ve done your homework and fully understand the company you want to invest in.
Investing in oil companies gives you some exposure to the vicissitudes of global oil prices, but it’s not the same as owning oil outright. The next closest thing is futures contracts. With these, you’re speculating directly on the price of crude oil. You can also look at investing in Crude Oil ETFs and ETNs. The upside is that you don’t need to worry about owning the actual commodity.
When you’re buying futures, you’re agreeing to pay a price for oil. Prices can go up after you’ve made your purchase, which can allow you to make a tidy profit by selling your futures contract. Alternatively, prices can go down to below what you paid for the contract.
Trading futures is mostly done by larger financial institutions because it’s a lot more complicated than buying and selling stocks. However, futures are rising in popularity among investors.
Thinking Big With Leases
More ambitious investors with access to land can go beyond trading futures and stocks and opt for an oil and gas investment lease. In these cases, oil companies pay a premium to lease your land in order to drill on it.
The terms are varied and differ on a case-by-case basis, so it’s important to do the research and ensure you’re getting a good deal.
Obviously, this doesn’t apply to most of the country. However, if you own property in an oil-rich area, then you could receive some excellent earnings.
Understanding Oil Wells and Gas Investments – The Risks
Just about any investment presents risk, and the oil industry can be especially volatile. Global politics plays a big part in the price of oil, so an event could drive prices up or down at a moment’s notice. Despite the risk, investing at least part of your nest egg in oil is a good idea for diversification reasons.
Anum Yoon is a personal finance blogger and writer. She created and maintains her personal finance blog Current on Currency. You can subscribe to her blog newsletter right here for her weekly updates