While pulling up to the gas station to fill an empty tank might seem routine, getting oil from the ground to your car requires work from a host of companies that each profit differently. Oil, a non-renewable resource, is responsible for essential parts of life, such as transportation and fertilizing crops. As a result, stocks in companies that discover and handle oil can be profitable investments for knowledgeable investors. Here’s how you can understand and purchase oil stocks. You can also work with a financial advisor who can advise you about specific types of assets and how investing in them could impact your finances.
Oil Stocks Explained
Investing in oil refers to buying stocks related to the oil industry and it typically provides exposure to companies that profit from extracting and refining petroleum. Besides fueling cars, petroleum is crucial for producing numerous goods, such as:
- Oil for heating residential and commercial buildings
- Plastics (from natural gas)
- Jet fuel
- Lotions and cosmetics
Oil stocks correlate with global supply and demand for petroleum. Over the last few decades, oil prices have spiked and dipped due to international circumstances and energy needs. For instance, before the current Ukrainian conflict, the COVID-19 pandemic caused energy usage to plummet in 2020, drastically reducing oil prices.
In addition, the global push to research renewable energy sources might drive down demand for oil in the future. However, current oil usage indicates that the world will likely rely on petroleum for years to come.
Because oil stocks’ profitability mirrors the demand for oil, they are not risk-free investments. The price of a barrel of crude oil varies like a company’s stock prices.
How to Buy Oil Stocks
Investing in oil stocks doesn’t mean purchasing oil or oil-rich land. Instead, just as you might buy stock in a company that sells technology or toothpaste, you can buy stock in companies that handle oil in some way, such as drilling or transporting petroleum. You can do this through any typical stock broker or brokerage account that you already have open.
Since purchasing stocks involves investing in specific companies, it pays to do your homework before making a financial commitment. Then, when you feel ready to invest in an oil company, you can use a brokerage account to buy and sell oil stocks.
Tips for Investing in Oil Stocks
Investing in oil stocks requires basic knowledge of the oil industry and market dynamics. Use these tips to get the most out of your investments:
1. Monitor Oil Prices
Generally, the more expensive a barrel of crude oil, the better oil stocks perform. As a result, oil prices affect oil stocks and jumping in at a specific price point can be the difference between gaining or losing on your investment. The cheaper you can buy into oil stocks, the more money you’ll make when you sell for a higher price.
2. Understand Your Investment Options
Numerous options are available for investing in oil. Because extracting and using production is a complex process, a host of companies are involved at every level of oil production:
- Exploration and production (E&P) companies, also known as upstream companies, assess areas for oil potential. They drill for oil in new places on land and in the ocean. Typically, share prices of these companies correlate heavily with oil and natural gas prices.
- Midstream companies profit by transporting, processing and storing natural gas and petroleum products. These companies generate income through contracts, making their stock prices steadier. Three of the largest publicly traded oil and gas pipeline companies are Enbridge, Enterprise Products Partners and TC Energy.
- Downstream operations refine oil and sell it – think gas stations and the refineries that supply them. They have direct contact with consumers. Downstream companies also produce widely used goods, such as fertilizer. And petrochemical companies use natural gas to produce a vast array and volume of plastics.
- Integrated companies combine E&P, midstream and downstream operations. These are usually massive multinational corporations like ExxonMobil.
- Oilfield services companies sell equipment and operational services to E&P companies. Drilling companies, for example, purchase rigs, bits and other machinery from oilfield services companies. Besides drilling companies, there are numerous publicly traded oilfield services companies, including Schlumberger, Baker Hughes and Halliburton.
3. Prioritize Dividends
Stock price increases aren’t the only way investors can profit from the oil industry. The gradual decrease in demand for oil is causing many companies to return more cash to shareholders instead of reinvesting money in more wells or refiners. Therefore, dividend payments from financially stable companies are an excellent alternative to capital gains.
4. Be Mindful of Potential Risk
The last few decades have been a roller coaster for oil prices. The boom and bust of the free market have caused volatility in oil stocks, meaning the next price fluctuation could have significant implications for your investments. So, researching your investments and setting goals – such as selling at a specific stock price or establishing dividend income – are crucial to success.
Alternative Ways to Invest in Oil
Stocks are just the tip of the iceberg when investing in oil. You can also put your money into the following assets:
Oil Mutual Funds
Oil mutual funds operate as they would in other industries, allowing you to invest in a collection of stocks simultaneously. Investing in oil mutual funds allows you to diversify your investments by spreading money amongst upstream, downstream and integrated oil companies.
Oil Options, Futures and Spot Market
Oil options and futures are contracts setting a specific price for an oil transaction in the future. The price defined in the contract is permanent, meaning that if prices increase in the months or weeks ahead, the contract rises in value because it enables a buyer to acquire cheap oil.
However, if oil prices drop, the contract becomes almost worthless because its permanent price is more expensive. As a result, oil futures require deep investment knowledge and are high-risk investments.
The oil spot market isn’t accessible to the average investor because of the money and space required. The spot market involves purchasing and selling thousands of barrels of oil. Therefore, wealthier investors might trade in the oil spot market.
Commodity ETFs, ETNs and MLPs
Oil exchange-traded funds (ETFs) and exchange-traded notes (ETNs) correlate with oil futures but don’t purchase the contracts. They give investors access to this volatile section of the oil industry without the additional risk of acquiring the contracts themselves. One of the primary differences between the two is that you don’t have to pay taxes on ETNs until you sell them, while you pay taxes on gains from ETFs each year you hold them.
Master limited partnerships (MLPs) focus on exploration, development, mining, processing or transportation of minerals or natural resources. MLPs often hold assets like oil or gas pipelines to generate cash flow. MLPs are pass-through entities, which means they aren’t subject to income tax. Instead, the income tax liability is passed through to the unitholders or investors. MLP distributions are similar to the dividends from a dividend-paying stock or mutual fund.
Energy Stocks and Equity ETFs
An energy ETF invests in an array of energy companies. These funds diversify your investment dollars, spreading risk across companies. For example, your investment in energy stocks might involve:
- An oil index
- Direct investments in ExxonMobil
- An ETF tied to an E&P company like SPDR S&P Oil & Gas Exploration and Production ETF (market handle XOP)
Should I Invest in Oil?
As with any investment, oil brings its own particular advantages and disadvantages. Because oil is a crucial resource for vehicle fuel, heat and various products, demand isn’t likely to decrease in the near future.
However, unforeseen and uncontrollable events, such as the COVID-19 pandemic and international conflict, can swing oil prices in both directions. As a result, oil is a volatile investment that requires industry knowledge and risk tolerance. While an oil ETF might be less risky than purchasing stock in an oil company, it’s not likely to be a fruitful investment unless you understand the dynamics of the oil market.
The Bottom Line
Oil stocks allow you to invest in companies involved in every facet of the oil industry. Whether you’re interested in a specific portion of the market, such as drilling, or want to diversify your portfolio with an oil ETF, you can purchase these assets through a brokerage account. However, doing your homework is vital to profit from your investments. The oil market is infamous for rising and plunging unexpectedly, so an uninformed investment will likely lose money.
Tips for Oil Stocks
- Oil investments are complex, and you can get exposure to the market through numerous asset types. Fortunately, you don’t have to research your options on your own. Financial advisors have the expertise and resources necessary to find the ideal investments for your portfolio. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Oil futures are a particularly complicated, risky investment. However, these contracts can be fruitful for involved investors not satisfied with “set it and forget it” type investments. For more, here’s the guide to oil futures.
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