Oil is a volatile commodity, the value of which is driven by supply, political and environmental factors — and the demands of energy-driven nations. There’s no telling which direction the oil supply of other oil-producing countries will go, and the Middle East is no stranger to conflicts that disrupt the oil industry.
Each of the four investment options available for this commodity comes with risk, given you’re making a bet as to how much oil will sell for.
How do I buy oil stocks?
Pick a trading platform. Choose a broker by considering its trading costs, fees and features.
Open and fund an account. Be ready to supply your ID, bank account information and Social Security number.
Find oil stocks. Use a stock screener to pinpoint stocks by company name or ticker symbol.
Submit your order. Once you’ve found a stock you like, indicate how many shares you’d like to purchase and submit your order.
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1. Invest in oil ETFs
Worth considering are exchange-traded funds (ETFs), which provide access to a variety of assets without putting all of your money into individual stocks. Rather than buying a stock, you’re buying an oil ETF, which typically tracks several oil stocks’ performance.
Purchasing commodity-based oil ETFs is a direct way to invest in oil. ETFs allow investors to minimize risk while taking advantage of the performance and general popularity of a particular sector. And oil ETF investors can avoid the risk of exposure to single stocks that fluctuate based on oil prices.
Oil ETFs can be a good choice for those who are new to investing or looking to diversify their portfolio, and you have many oil-based ETFs to choose from, covering many companies in the industry. Here are some of the more popular options:
US Oil Fund (USO): An ETF that directly tracks the price of oil through futures contracts on the benchmark West Texas Intermediate (WTI) crude oil.
VanEck Vectors Oil Services ETF (OIH): An ETF that tracks an index of the stocks of companies that provide support services to oil producers and explorers.
Leveraged ETFs If you’re considering a leveraged oil ETF like UCO, be careful. Leveraged ETFs are not designed to be bought and held for long periods of time — rather, they’re designed for short-term trades.
To achieve double or triple the returns of the futures or stocks they’re based on, these ETFs invest in options and derivatives that require a daily rebalancing of the ETF’s assets and target exposure. Therefore, the asset base is constantly changing, and extreme volatility can erode the basis of your investment.
Pros
Instant diversification across the oil industry
Track record of providing safe and reliable growth
Cons
You relinquish some control over the split of assets
Leveraged ETFs are designed only for short-term trades, not buy and hold
2. Invest in MLPs
Existing primarily in the gas and oil industry, a master limited partnership (MLP) is a tax-advantaged corporate structure that combines the tax benefits of a partnership with the liquidity of a public company. Like a partnership, profits are taxed only when investors receive distributions.
MLPs typically own the pipelines that carry the commodity from one place to another, and they are known for paying high dividends, which makes them a popular option for investors who are seeking a long-term stream of income. MLPs are still volatile, though, and risks could come from a slowdown in energy demand, environmental hazards, commodity price fluctuations and tax law reform.
Understanding the energy cycle, the industry’s landscape and the impact of price fluctuations can help you determine valuable oil-related assets.
Pros
Choose from a range of stocks, and cash out when you want
Access the market through an online broker or financial advisor
Cons
Large oil companies are involved in refining, which doesn’t benefit from higher oil prices, and so stocks aren’t necessarily in lockstep with the price of the commodity
Individual stocks can be more volatile than diversified ETFs
4. Invest in oil futures
Futures are the most direct way to purchase this commodity without literally purchasing barrels of oil, but they’re a more advanced and complex investment option the majority of brokerage accounts don’t offer. You buy a futures contract through a commodities broker to purchase oil at a future date at a specified price. Purchases must take place before the contract expires.
Futures are extremely volatile and riskier than other investment options. You must be correct on the timing and price movement to see a profit. If you’re interested in futures, you’ll first have to choose a brokerage account that supports futures trading.
Pros
One of the most actively traded futures on the market — and the most liquid
Cons
Requires a specific brokerage platform that offers futures trading
Volatile investment without ability to predict with certainty how prices will fluctuate
Worthless if you fail to exercise your contract prior to its expiration
The graph below tracks the price per barrel of oil in US dollars over time.
What are the risks of investing in oil?
While long-term investments in oil companies can be highly profitable, understand the risk factors before making investments in the sector:
Price volatility. Wide price fluctuations can occur daily due to unpredictable influences like supply and demand.
Dividend cuts. If a company is unable to earn enough revenue to fund payments to investors, it may cut dividends.
Oil spill risk. Accidents can cause a company’s share price to drop significantly. In 2010, BP saw a decline of more than 55% to its stock in the wake of the Deepwater Horizon oil spill.
Bottom line
Get involved in oil through four main methods, each with its own set of risks. Before you buy, explore investment options for other tangible goods through multiple trading platforms.
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