Unlike stocks in a company or mutual funds in a collection of companies, oil functions as a commodity with a price swinging up and down depending on demand for production. However, unlike precious metals, which are priced based on a perceived value, oil is most often driven by consumption and steady supply to ensure that transportation and infrastructure continue. For example, if someone were to produce a nuclear battery that could power a car, the price of oil would probably drop to a fraction of what it is today because there would be no need for gasoline or diesel. On the other hand, gold would still be considered valuable and in high demand.
By its nature, the oil and gas industry operates in cycles of bullish and bearish activity. If you invest in oil, consider that a portion of your portfolio is exposed to a volatile industry. There have been many cases where an economy boomed, but crude oil prices cratered and performed as a poor investment. And the opposite has occurred as well. Keeping in mind the disconnect of oil from the rest of the investment market can help you better understand these investment options.
Oil Stocks and Energy
If you want to dive into oil investing, you’re often looking at investing in an oil company through oil public offerings (stocks). With oil stocks, you’re actually more aligned with a company performance than the price of the commodity, ironically. Investments like Chevron (CVX), Exxon (XOM), British Petroleum (BP) and Halliburton (HAL) give an investor a stake in oil as it translates to a company’s success in the industry.
Oil Futures: Betting on the Market Ahead
On the other hand, if you really want to risk your shirt, then you’re going to be looking at oil futures. This involves essentially making an investment position on where the price of oil is going to be in the near future. It takes in-depth research about the market, as nuances can cause price swings to occur right when your future option comes due.
Essentially, investors buy a contract that means they’ll sell a stake in oil commodities back by a certain date. If the price of oil rises, then the contract will profit the holder. If, however, the price drops, then the holder still has to make good on the contract at a personal loss. When these contracts run in the thousands of dollars, a loss can be a big hit.
Oil futures play different sides of the oil industry as well. There are futures for heating oil, crude oil supply, airline fuel and more. All of these submarkets have their own swings. Again, lots of research in the given market is a necessity before putting down stakes in oil futures.
Going Into Oil ETFs or Oil Mutual Funds
If you’re a passive investor or don’t have time to research hours of reports every day, then an oil mutual fund or an exchange-traded fund (ETF) may be better choice. These investment tools are particularly good for beginners with little investing experience.
An exchange-traded fund is a portfolio of investments set on auto-drive. They are calculated mathematically based on a given index or metric. So, oil ETFs operate to match as best as possible the average of an oil industry average investment value metric. If the market metric goes up, the oil ETF will automatically adjust to match it. If the metric goes down, so does the ETF.
ETFs can work well for those who want to take out a position for the long run, assuming an overall market is rising. They don’t want to fuss with details, and they don’t want to pay extra fees for a fund manager. ETFs are easy to invest in, and many trade like stock shares, allowing investors to buy a little or a lot. Common oil ETFs include U.S. Oil (USO) and iShares Global Energy Sector Index Fund (IXC).
An oil mutual fund is also a portfolio, but unlike oil ETFs, the mutual fund is managed by an expert fund manager. The mutual fund is designed to produce a target in an investment arena, but the fund manager decides what to sell and buy to ensure it makes a profit. Mutual funds cost a bit more, but the output from the fund manager’s decisions often pays for itself with a higher return. Again, this is a safer haven for a beginning investor than going it alone (not perfectly safe like a bank deposit, mind you).
Most oil mutual funds tend to be a blend of energy stocks such as the T.Rowe Price New Era Fund (PRNEX). The key in oil ETFs and mutual funds is that they both diversify holdings more than holding a few stocks.
Invest Directly in Oil Wells
Another option is to invest directly in oil wells, with a company like EnergyFunders. You can select how many projects to invest in, which ones and at which amounts. If you invest directly in wells, the oil price affects your investment, but how a company performs overall won’t affect it, unlike with oil stocks. Your investment’s value comes from the success of the individual projects you select, unlike oil mutual funds or ETFs. You also don’t have to predict potential oil prices, as with oil futures.
Direct investment in oil and gas has several benefits over the previous investments:
- Tax benefits: You can take tax deductions for drilling costs, up to 100% of your investment amount.
- Higher upside: By taking the risk as an equity investor, you reap all of the reward.
- Better control: You pick and choose your own investments and projects. You’re not relying on someone else to place the capital.
Questions to Ask
Before you invest, ask yourself a few questions to determine the best way to invest in oil for you:
- Do you feel comfortable with your understanding of the oil market? If the answer is “no” or not sure, go do more research. There’s plenty of it for free on the Internet. Come back when you have a good grip on how the market works.
- Are you a passive investor or an active one? If passive, funds are going to be the better play. If active, try some money on company stocks and keep a bigger reserve in funds at first. That way you won’t lose your shirt on your first investment if the market happens to tailspin the day you enter.
- What’s your goal for investing in oil? Is it to be a counterpart to the rest of your portfolio? Oil should have an investment factor that you already know how it will play out in your portfolio. If you’re just choosing oil because there are lots of big gasoline companies out there making money, that’s a poor reason to invest. Make sure you have a strategy on how oil fits into the bigger picture of your investment goals.
- Are you investing for retirement or personal profit? Retirement investing can have a longer time span if you’re young, allowing you to take riskier investments in oil that recover over time. But if your time is near, oil can be risky for a portfolio you need stability in. If for personal profit, don’t forget how taxes play on capital gains. It can be a big bite out of your profits if sold too quickly. (This is why we recommend taking tax deductions for oil and gas investing).
At EnergyFunders, we give you access to invest directly in oil wells. We carefully vet oil and gas projects with proven operators and give you all the information so you can select projects that are right for you. Sign up to view our current investments and start to invest directly in oil wells.