How can I buy oil as an investment?
Investors have many options for getting involved with oil. These methods come with varying degrees of risk and range from direct investment in oil as a commodity, to indirect exposure in oil through the ownership of energy-related equities.
Futures and Options
One direct method of owning oil is through the purchase of oil futures or oil futures options. Futures are highly volatile and involve a high degree of risk. Additionally, investing in futures may require the investor to do a lot of homework as well as invest a large amount of capital.
ETFs and Mutual Funds
Another direct method of owning oil is through the purchase of commodity-based oil exchange-traded funds (ETFs). ETFs trade on a stock exchange and can be purchased and sold in a manner similar to stocks. For example, buying one share of the U.S. Oil Fund (USO) would give you exposure to roughly one barrel of oil.
In addition, investors can gain indirect exposure to oil through the purchase of energy-sector ETFs, like the iShares Global Energy Sector Index Fund (IXC), and to energy-sector mutual funds, like the the T. Rowe Price New Era Fund (PRNEX). These energy-specific ETFs and mutual funds invest solely in the stocks of oil and oil services companies and come with lower risk.
If you are looking for more information about investing in oil companies, Investopedia's Advisor Insights tackles the topic by answering one of our user questions.
As an investment, there are many ways that you can buy oil commodities. You can also buy various securities that give an indirect exposure to oil. You can even buy actual oil by the barrel.
Crude oil is the world's most actively traded commodity. It trades on the New York Mercantile Exchange (NYMEX) as light sweet crude oil futures contracts, as well as other commodities exchanges around the world. Since oil is a commodity that is produced and in large quantities that are costly to transport, it trades in futures contracts. Futures contracts are agreements to deliver a quantity of a commodity at a fixed price on a fixed date in the future.
Oil options are another way to buy oil. Options are contracts which give the buyer or seller the option to trade the oil on a future date. Options often have cash settlement, meaning that on the exercise date of the option, the buyer and seller just pay each other off based on the current price of oil rather than delivering the real physical oil to each other. If you choose to buy futures or options directly in oil, you will need to trade them on a commodities exchange. You can open a managed account at a brokerage firm. With a managed account you can ask your broker to make the trades for you and advise you in the various risks associated with trading commodities.
The more common way to invest in oil for the average investor is to buy an oil Exchange Traded Fund (ETF). An oil ETF is a fund that trades in real time price changes on major stock exchanges. It is designed to closely track the movements of the price of crude oil. What the fund does is maintain various investments in the above mentioned oil futures and options markets, and then sells shares of its fund to smaller investors. Some common oil ETF stock ticker symbols are OIL, USO, UCO, and DBO. You can buy into or out of these funds any time during normal market hours, and you can buy shares in small quantities as opposed to the hundreds of thousands of dollars you need to invest in futures and options.
Finally, you can invest in oil through indirect exposure by owning various oil companies. These companies tend to own large amounts of oil and therefore their stock prices move in approximate correlation to oil's price.
First you want to know what stage? Development, Refinery or Distribution. Or, maybe, you just want to buy the commodity.
Next, you want to ask yourself whether you want direct investment or indirect investment.
Direct investment would be in form of MLPs (Master Limited Partnership). You own shares of the investment company actively engaged in oil development/refinery/distribution. This is high risk and very illiquid.
Indirect investment is owning a mutual fund or ETF that invests in the companies engaging in the oil business. In this case, you own a portfolio of oil related investments, so it is more diversified and less risky.
Or, you can own the stock of a mature company like Chevron, British Petroleum that actively engages in the oil business.
Oil investment is very tricky. It is not about just supply and demand. There are a lot of political factors involved. Example: How do you account for the environmental impact from oil excavation? What is the recent production limit from OPEC countries? Were they able to limit supply? All these factors have an immediate impact on oil prices.
In general, oil investment is very speculative. Investors should proceed with caution.
Investing in crude oil requires careful consideration, because you have many different choices. Because crude oil is a physical commodity, directly investing in oil requires proper handling and management of the physical good, and that involves logistics that many traditional investors in the stock market aren't comfortable taking on in their portfolios. There are other ways to invest in crude oil that offer simpler handling, and they have advantages and disadvantages as well. Among the ways to invest in crude oil are:
- Owning physical crude oil itself.
- Investing in crude oil futures contracts that give you the right to take future possession of the physical commodity.
- Investing in exchange-traded funds that seek to track the price of crude oil.
- Investing in energy companies that explore for, produce, transport, refine, or sell crude oil.
We'll look at each of these investments in a little more detail and look at the “pros and cons” as there is no perfect investment. Some of these investments can be owned in IRAs as well, but may have issues (such as Unrelated Business Income Tax or UBIT) or the need for a Self-Directed IRA).
Owning Physical Crude
Owning actual crude oil ensures that the value of your investment will rise or fall with the market price of crude, but it's very difficult for the ordinary investor to do. Storing crude oil requires special handling because crude oil is toxic and volatile. Typical storage facilities include rail tankcars and the huge oil storage tanks that you see near refineries and pipelines, and the sheer volume of crude is more expensive than most ordinary investors want to invest. Add in storage fees, and the shortcomings of directly owning crude outweigh the advantages for most investors.
The physical component can also be done by owning a shares in oil and/or gas wells (these can be tricky and typically come with a K-1. If in an IRA, this would have to be done in a Self-Directed IRA. If done in a taxable account, you may have the ability to take some income tax deductions related to tax-breaks such as deductions for IDCs or Intangible Drilling Costs, etc.
Investing in Crude Oil Futures Contracts
Crude oil futures contracts offer a method for investors to get exposure to price of crude without having to deal with the storage and other issues involved in owning the physical commodity. Futures contracts let you arrange to buy or sell a certain amount of oil in the future, with the price fluctuating with the market. If you buy a futures contract and the price of crude goes up, then you profit. If it falls, then you'll lose money, and the contract seller will end up being the one to make money on the contract.
Crude oil futures contracts give investors the chance to have a highly leveraged investment. For instance, the contract unit for CME Group crude oil futures is 1,000 barrels, currently worth around $50,000. However, the current maintenance margin required is just $2,500, meaning that you only need about 5% of the total contract value in your futures brokerage account. That doesn't prevent you from suffering losses above that amount, however, so it's important to understand that this leverage is a tool that can work for or against you. These investments using futures contracts typically create UBIT and you should take care when owning these investments in an IRA.
Investing in Crude Oil ETFs
Exchange-traded funds make it easier for investors to invest in certain areas, and there are crude oil ETFs that offer exposure to the price of the commodity. However, it's important to understand how such ETFs work, because in some cases, they won't perform the way you might expect and can therefore be disappointing over the long run. This is especially true when using “leveraged ETFs” that give you multiples of the daily price changes in Oil.
The United States Oil Fund (USO) the best-known oil-tracking ETF, with the goal of moving up or down in line with the price of West Texas Intermediate crude oil futures on a daily basis. The fund does a good job of accomplishing that goal, but what it doesn't do is track longer-term changes in crude. Because the ETF doesn't want to take physical possession of crude oil, it simply rolls futures contracts forward when one expires. The main problem with that strategy is that futures contracts for the current month tend to be less expensive than contracts for future months. The result is that the fund usually takes small losses every month because of the rollover process (many times called a “roll-risk”), and over time, those losses add up to become very large declines -- even when oil prices are flat or trending higher.
Owning Stocks of Companies in the Crude Oil Business
The best way for most investors to invest in crude oil is through the companies that explore for, produce, transport, refine, and sell crude. Some of these companies, such as exploration and production companies, tend to rise in value when crude climbs and fall in value when crude drops. Other parts of the industry have more complex correlations with crude prices. For instance, the refinery industry relies on crude oil as an input for producing gasoline, diesel fuel, and other refined products. If crude oil prices rise without a corresponding increase in the price of refined energy products, then investors can expect refinery stocks to fall, because their profits go down.
Individual stocks are available for investors, but you can also buy energy ETFs that own a wider variety of stocks in the industry. By choosing companies that can profit both from rising oil prices and through smart operational decisions, you can increase your chances of investing successfully.
Investing in crude oil has plenty of profit potential, but you should focus on the methods of investing that work best. Most investors are most comfortable finding stocks that will benefit from crude oil movements rather than buying crude directly on their own.
I like baskets of companies because of acts of Gods. ie you can do all the research you want but you can't predict a political event, natural disaster or in some cases fraud. The two investments I like are USO, an ETF, that represents a basket of investments in oil or oil futures and a better "less risky" investment AMLP, which is an ETF that invests into an index of oil and gas pipelines. This ETF is one that I own for clients that pays approximately a 9% dividend, is a basket of 23 companies. These companies have been hurt due to low oil prices, but they act as a toll booth on a highway that always makes money as oil & gas passes its pipeline. In addition, this asset class has 20% upside when oil prices normalize between 60 and 80 per barrel.