How to invest in oil
There are many ways to invest in oil and gain indirect exposure to this in-demand commodity. Also known as ‘black gold,’ oil is used for fuels, lubricants and asphalt, as well as to make plastic and synthetic materials used in everyday household items, from toothbrushes to nail polish. Find out how to get started in oil investing…
Why you should be investing in oil shares
Despite the rise of renewable energy sources, the global economy still runs on crude oil, and the oil price still acts as a barometer of economic health. But ‘black gold’ is a finite resource that is becoming harder and more expensive to get out of the ground, which is why oil bulls think it will become a scarce commodity in future and hence a good investment.
Oil price movements are linked to changes in supply and demand, and the time lag between supply ramping up to meet demand creates tactical opportunities for investors.
Oil hit an all-time high of $145 a barrel in July 2008, just before the financial crisis unfolded, but it had plunged to just $33 by February 2009 as Chinese demand waned and US producers used technology to extract oil from shale formations. Today, the spot price (meaning the current market price you would get if you bought or sold it for immediate delivery) is around $50 a barrel.
Top four ways to invest in oil
Although oil prices can be volatile, the commodity can act as a good diversifier within a portfolio as it does not tend to move in line with stocks and bonds. If you want to tap into the oil story, there are several ways to do this.
Invest in oil futures
Buying physical oil is not an option for most investors, unless you fancy storing barrels of a flammable commodity in your backyard. Buying futures is the next best thing to getting direct exposure to oil. Futures give you a contract to buy or sell a certain quantity of oil at a certain price on a future date, but prices can be affected by the cost of transporting and storing oil, not just the spot price. Plus, if the price of futures is higher than the expected spot price, investors can end up making a loss even if the oil price goes up.
Futures trading is a complex strategy which can involve trying to time the market as well as making a bet on the direction of the oil price, so it probably isn’t suitable for novice investors.
ETFs and ETCs
Exchange traded funds (ETFs) can invest in physical commodities, futures contracts, or company shares. ETFs are popular because they can be traded as easily as if they were stocks, and they offer a cheap way to mirror the performance of major markets, without paying high active management fees. You can also buy ETFs that ‘short’ the oil price, meaning they make money when it falls.
Exchange traded commodities (ETCs) track a single commodity or a particular commodities index using derivatives like futures contracts, so their performance can diverge from the spot price. Like ETFs, they are liquid and easy to trade. A better option might be to buy a commodities product which gives you exposure to a wider range of energy investments, not just oil, helping to spread your risk.
Search our ETFs Screener for oil- and other commodity-related ETFs.
A fairly straightforward way to tap in to the oil story is to buy shares in oil companies. The largest oil companies in the world include BP, Royal Dutch Shell, Total, ExxonMobil and Chevron. You can trade individual stocks through a broker or via an online share dealing account, but sometimes charges can be high for individual trades so look for a provider with competitive dealing costs. A nice bonus of holding oil company shares is that many of them pay decent dividends.
You should bear in mind that oil company stocks will not necessarily move in line with the oil price. Many other factors affect the profitability of a company, and it will have other lines of business, such as refining and processing, which could affect how it performs. There are many smaller companies involved in oil exploration or oil services that you could also add to a portfolio, but the explorers in particular tend to be high-risk investments.
It is estimated that oil companies need the price of Brent crude to be around $50 a barrel in order for them to make a profit, so some producers are under pressure with the price at its current level.
Energy companies make up a large part of many major markets, so if you own a fund that invests in, say, the FTSE 100 or the S&P 500, the chances are you already have some exposure to the oil sector. For example, one of the most popular funds among UK retail investors is the £11.6 billion Invesco Perpetual High Income fund, which has almost 5% of its portfolio in BP.
But if you want greater exposure, choosing a fund with a mandate to invest only in oil is an option, such as the Junior Oils Trust, which focuses on small and mid-cap oil exploration companies. Although these stocks might be riskier, they stand a chance of being bought up by larger firms, which could bring a nice payday for shareholders. If you want to spread your risk, fund houses such as BlackRock, Schroders, Investec and Artemis offer global energy funds which cover a broader investment universe including gas and other energy sources. They may also hold companies which service the energy industries, as well as the producers themselves.