How To Invest In Oil

Do Lower Oil Prices lead to Greater Opportunities?

How To Invest In Oil
April 21, 2016

For most Americans, a prolonged period of unusually low oil prices is a positive. It costs less to fill your tank at the gas station, and lower transportation costs keep the price of goods relatively low. However, there are a few people who are not happy to see low oil prices — led by those who work, or invest in, oil and oil-related industries. A mere eighteen months ago, a barrel of oil was over $100. As of this writing, it trades near $40 per barrel.

Using the logic of "buy low and sell high," is this a good time to invest in oil? It may be, as prices are certainly going to rise at some point in the future. How far away will that be, and what is the best way to invest in oil when the time is right? Nobody can tell you with absolute certainty how the oil market will respond over the next few days, much less over the coming years — but it is possible to give you some points to consider as you lay out your investment plans.

Start by assessing your own situation in three aspects: time, risk tolerance, and investing acumen. These three factors should help you determine your preferred investing path.

Trading in oil is not like trading in gold, where you can purchase and hold the physical asset. Purchasing oil is often done through futures contracts, where you pay for the right to purchase a particular amount of oil at a specific future price. Most investors do not have sufficient acumen, risk tolerance, or time to invest in futures directly — not to mention the space to store 1,000-barrel increments of oil if you end up having to accept a delivery.

For the average investor, oil investments are made through the stocks of companies in the fields or investments in exchange-traded funds (ETFs). Both provide a simpler way to invest in oil, but also require homework and decisions. Drops in oil prices do not affect all energy-related stocks in the same way.

When oil prices are low due to oversupply, as they are now, companies that engage in the oil-field support functions suffer the most. For example, Halliburton (NYSE: HAL) provides oil rigs and other support services and is being pummeled with no end in sight. Halliburton stock will rise again, but not until oil producers lower production and demand absorbs the current oversupply. Time that correctly, and you will make money. Exploration companies are hit equally hard, and will take just as long to recover.

Traditional oil companies like Chevron (NYSE: CVX) and ExxonMobil (NYSE:XOM) are vertically integrated, meaning they own operations throughout the supply chain. The diversity within the energy field tends to keep their losses tempered, as downstream areas of their business benefit from the low price that harms the upstream side. Conversely, the upsides are lower compared to oil futures if you do buy in at the lowest price.

ETFs can fall in either camp, depending on what they track. Some ETFs trade directly in futures, bringing the higher risk and reward associated with futures with less of your time spent analyzing the market. Others invest broadly to spread out the risk, mixing large cap energy companies with riskier exploration and support companies. Some diversify into natural gas and other energy sector holdings — even alternative energy for the ultimate in diversification.

In short, low oil prices are a great opportunity to make money — or to lose money. Treat them with the same care as you would any other investment opportunity. Do your research to assess the condition and likely future of the individual stock or ETF, rather than just betting on a future price. Stay within the boundaries of your risk tolerance and portfolio needs, and take advantage of any deals that you find.


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