Oil is a crucial component of modern society and remains one of the most important commodities. It comes as no surprise that investing in oil is a popular choice among investors. Despite the growing presence of green energy, oil will continue to play a significant role in economies for the foreseeable future, which provides a stable foundation for its price.
Investing in oil offers the same safe-haven potential that attracts investors to gold. It also serves as a hedge for investment portfolios, allowing advanced investors to offset potential losses from a rise in oil prices. This protection can be valuable given the often volatile nature of oil pricing.
Here are five different methods for investing in oil, ranging from direct to more indirect approaches.
5 ways to invest in oil
1. Oil ETFs
One convenient way to invest in oil is through oil exchange-traded funds (ETFs). These funds own futures and options contracts related to crude oil, rather than the physical commodity itself. This structure allows the ETF’s price to mirror changes in the spot price of oil, although not perfectly due to the fund’s investment strategy.
If you anticipate a rise in oil prices but prefer not to manage futures contracts independently, an oil ETF can be a suitable option. However, it’s important to note that ETFs focused on oil may be more suited for short-term trading rather than long-term investments.
Some of the major oil ETFs include United States Oil Fund (USO), Invesco DB Oil Fund (DBO), and ProShares K-1 Free Crude Oil Strategy ETF (OILK).
Risks: Investing in oil carries inherent risks due to the commodity’s volatility. Oil ETFs may be better suited for short-term trading during economic upswings. Additionally, these funds may not perfectly track the price of oil due to their indirect investment approach.
2. Oil futures
For more hands-on oil trading, investors can consider oil derivatives known as futures. Futures contracts allow individuals to purchase oil at a predetermined price in the future, requiring only a fraction of the contract’s value upfront. While futures offer significant leverage and potential profits, they also pose a risk of substantial losses if oil prices move unfavorably.
To trade oil futures, investors typically need to work with a broker that offers futures trading, which often necessitates a higher account minimum compared to traditional stock brokerage accounts.
Risks: Due to the leverage involved in futures trading and oil’s volatile nature, investors can experience rapid gains or losses. When oil prices move against them, investors may need to inject additional capital to maintain their futures position or risk premature closure at a disadvantageous price.
3. Oil stocks
Investing in oil stocks involves owning shares of companies involved in oil exploration and production (E&P). These companies offer multiple avenues for profiting from rising oil prices, as investors can benefit not only from price increases but also from production expansions that boost profitability.
As the price of oil rises, each barrel produced becomes more lucrative for oil companies, potentially leading to accelerated profit growth compared to oil price movements.
Risks: Individual stock investments demand thorough research and monitoring, as success is not guaranteed by random selection. To enhance the likelihood of success, investors should focus on well-established companies rather than those in early stages or exploration phases. Moreover, individual oil stocks can be as volatile as oil prices, resulting in a potentially turbulent investment journey.
4. Oil stock ETFs
For those averse to investing in individual oil stocks, oil stock exchange-traded funds (ETFs) provide a diversified alternative. These ETFs hold shares of multiple oil companies, reducing the risk associated with relying heavily on a single company’s performance.
Popular oil stock ETFs include Energy Select Sector SPDR Fund (XLE), Vanguard Energy ETF (VDE), and SPDR S&P Oil & Gas Exploration & Production ETF (XOP). With low expense ratios ranging from 0.09% to 0.35%, these funds offer cost-effective diversification.
Risks: While diversification shields investors from company-specific challenges, it may not safeguard against industry-wide issues like sustained oil price declines. Investors should carefully assess fund holdings to ensure alignment with their investment objectives, as ETFs may feature non-oil company components.
5. Oil stock mutual funds
Oil stock mutual funds present another diversified investment avenue, offering exposure to a range of oil companies while mitigating risk. These funds enable investors to capitalize on oil price uptrends while benefiting from reduced exposure to individual stock volatility.
Key oil stock mutual funds include Vanguard Energy Fund (VGENX) and Fidelity Select Energy Portfolio (FSENX), each featuring varying expense ratios and holdings. While these funds prioritize oil producers, they may also include businesses with lesser oil price sensitivity or related industries like coal or solar.
Risks: Similar to oil ETFs, mutual funds’ diversification shields against company-specific challenges but may not buffer against broader industry impacts such as plummeting oil prices. Evaluating fund holdings is crucial to ensure alignment with investment preferences and objectives.
What makes oil an attractive investment for many investors
Oil’s investment appeal stems from several favorable attributes:
- Strategic importance: Oil’s strategic significance ensures its continued necessity despite emerging energy alternatives.
- Strong demand: The diverse applications of oil guarantee sustained demand, supporting price stability.
- Long-term price appreciation: Historical oil price trends indicate long-term growth potential, incentivizing ongoing exploration and production.
- Volatility: Oil’s price volatility attracts traders seeking short-term profit opportunities.
- Defensive asset: As a valuable and essential commodity, oil can serve as a long-term store of value.
- Portfolio hedge: Investing in oil can offset risks associated with rising oil prices in other investment holdings.
Similar to gold and silver, oil serves as a viable trading alternative.
Bottom line
Investors have multiple avenues to capitalize on oil price movements based on their risk preferences and investment objectives. Oil funds or futures offer attractive trading opportunities, while individual oil stocks may present long-term growth potential for investors.
Editorial Disclaimer: Prior to making any investment decisions, investors are encouraged to conduct thorough independent research on investment strategies. Additionally, past performance of investment products does not guarantee future price appreciation.