Updated 03 September 2020
Oil is one of those investments that has its own mystique, conjuring images of oil barons prospecting for the Black Gold. The reality is more mundane, and oil stock are no more likely to make you rich than any other class of assets or alternative investments. However, because oil prices are highly volatile (and therefore high risk), they do have the potential for delivering large short term gains – if you’re lucky – or big losses (if you’re not).
There are a number of ways to invest in oil, including direct and indirect investments.
Oil stocks are highly sensitive to changes in global supply and demand. To put it crudely, if demand is high or supply decreases, oil prices will rise. If new reserves are discovered, or demand falls, prices will drop. Geopolitical events like the Covid-19 pandemic, Brexit, the Russia-Saudi price war, and changes in global macroeconomic activity, can also drive the price up or down.
The Organization of the Petroleum Exporting Countries (OPEC) is an international organisation set up to try and keep oil prices relatively stable and fair. Its member countries control around 75% of the world’s crude oil reserves and produce 42% of global crude oil output. OPEC remains the primary driver of oil prices, but the USA (as the largest oil-producing nation) is enjoying a resurgence thanks to new shale oil reserves, and is challenging its domination of the sector.
Anyone considering oil as a potential investment should especially consider these factors:
Oil is not a good option for highly risk-averse investors. As well as price fluctuations and sensitivity to economic, political and diplomatic events, accidents like oil spills can also negatively impact stock prices, due to costly clean-ups and legal consequences. Also it will not suit those looking for ethical investments.
On the other hand, the world’s largest economies rely on fossil fuels, and oil in particular. Despite the global trend towards renewable energy sources, fossil fuels are still estimated to provide 85% of our global energy. The demand for oil investment is therefore like to linger for some time yet.
The level of sophistication in oil trading should also not be underestimated. Though people talk about ‘the price of oil’, there is in fact no single oil price. Unlike, say, gold or platinum, oil is not just one asset, but over 150 different oil blends and indices, all of which can rise and fall in price independently (though there is often correlation). As such, trading in oil is often more like trading in shares than it is like trading in commodities.
If you are already an experienced investor in stocks & shares and want to explore new challenges, and the ethical angle does not deter you, then oil stocks could well enhance your portfolio. A typical use for them might be in the small ‘high risk’ slice of your portfolio, where you can generate strong returns without putting too much of your capital in jeopardy. You could also consider oil stocks as part of a SIPP.
There are a number of different ways to invest in oil. Each option has its pros and cons.
You can invest in oil indirectly by purchasing shares in oil companies, such as Exxon Mobil or BP. This strategy is the most accessible for experienced investors, as it’s the same process as buying shares in any sector. If oil prices are low and you’ve got the patience for a long-term investment, buying into an oil company could be a less hair-raising ride.
Exchange-traded funds (ETFs), are a way of buying direct shares in a single type of oil, like Brent Crude oil. They’re bought and sold in a similar way to stocks but are traded on their own stock exchange. These products fluctuate in price throughout the day as they’re sold and bought, as they do not have a set trading window. This means they can be useful assets if you’re looking for a shorter term or liquid investment.
You can also invest in an ETF that covers a number of different energy commodities, such as natural gas and heating oil. Choosing an ETF with a broader focus may offer more protection from market volatility, but it’s still riskier than traditional shares.
Investing in oil ‘futures’ is the riskiest strategy and requires you to have significant capital. Essentially, a buyer will agree to purchase oil stocks at a later date for a set price when the ‘futures contract’ expires. The price they agree to could be very different from the current market price, as it uses a complex model to predict future cost. This can lead to huge wins or losses for the buyer or seller when the price inevitably shifts in one’s favour. Essentially, it’s gambling.
An option gives you the chance to buy or sell oil at an agreed price. Unlike a futures contract, there’s no obligation to go through with the transaction, making it less risky. All you need to do is decide by the expiration date if you’d like to go ahead. To give yourself the luxury of backing out, you will generally have to pay a premium.
You may need help from both an IFA and a specialist oil broker or stockbroker to give yourself the best chance as an oil investor. IFAs are generally not stock-pickers and will not advise you on particular stocks or shares. They will, however, help you understand how much risk you can afford to take, and therefore how much of your money you can reasonably speculate on the oil markets. Bear in mind that their advice may well be ‘Don’t do it!’ If they do give you the green light, be sure to listen to their words of caution and don’t invest more than you can afford to lose.
An oil broker or specialist stockbroker can give you more in-depth tips on the investment itself. However, remember that a stockbroker is not bound to act in your best interests, unlike an IFA who is.
There are many ways to invest in oil. You can do it yourself using a trading account, which can be opened online with a number of stockbroking companies. This option is best suited to experienced investors who understand the oil market and understand the complex factors that can quickly alter its price. If you feel confident enough to look into futures and options contracts, this may suit you best.
However, if you’re new to the world of investment, or have never invested in oil before, ask your IFA about the best vehicle for you. Remember that however you approach your investment, returns aren’t guaranteed and you may lose more than you invest. Nevertheless, an IFA can help you ensure that you don’t take more risk than you are able to tolerate, and design your investments in line with your overall financial goals.
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