How to Invest in Oil? A Beginner’s Guide to the Oil Market
Despite its large price fluctuations, the oil market remains one of the most lucrative markets an investor could invest in.
The oil market is one of the most lucrative markets an investor can invest in. Despite the large fluctuations in prices that occur even at a daily rate, many investors are still pouring their money into it since it is worth the risk for them. The oil market is a profitable market for investors, especially if managed correctly. Because of these, it is not surprising that many ventures in this industry.
Many investors gained and increased their wealth through this industry. But many also lost a portion of their funds and wealth to it. And that is not new; the same happens to other forms of investments, oil is no exception for that. Like other typical investments, there are still risks that linger, but if one knows the factors that drive the oil market, they can reap gains from it provided that they have a good strategy.
These reasons attract both new and seasoned investors to this market; the problem is that sometimes they do not know how to (especially the beginning investors). Therefore, knowledge about this market is a must if you consider including it in your portfolio. And this article will give you that. This article provides a screenshot and overview of the factors that affect the global oil market and the ways in how you can have a stake in it and include it in your portfolio.
What are Oil and Petroleum?
When you hear the word “oil,” maybe the first thing that comes into your mind is the oil used in the kitchen. And that is totally acceptable. However, this oil is different from the one in the market. The oil you use in the kitchen comes from vegetables like soybean or animals like fish. These oils, therefore, are edible. On the other side, the oil being talked to in the market is the non-edible oils or oils derived from petroleum.
Now, does the word petroleum ring a bell? Yes, it is the one being put in the car to serve as fuel. However, petroleum goes beyond this description. It is more complex than waiting for the local gas station’s price to dip until you get a full tank.
The oil being used as fuel is part of the collective term “petroleum,” which is used interchangeably with oil. Crude oil is the naturally occurring liquid beneath the surface of the Earth, and companies get these oils through oil drilling. Petroleum comes from these crude oils; upon the refinement and processing of the latter, the former is produced.
Petroleum is not only fuel for your car. It serves various purposes, and a lot of products are derived from it. Here are some of the products made from oil
· Heating oil
· Jet Fuel
· Floor Wax
· Diesel Fuel
· Bicycle Tires
· Rubber Cement
Factors That Affect Oil Price
There are lots of interacting factors that affect the price of oil in the world market. However, two of these many factors have a more considerable influence on the overall price. These two factors are demand and supply.
Supply and demand affect oil like other typical commodities. However, the effect of these two in the former is more known to the general public as it attracts more attention and coverage. In addition to this, the global oil market is one of the biggest global commodity markets. It is so enormous that it would still be bigger when compared to all raw metal markets combined.
Given these, you would realize how the role of these two factors affects the oil market and the world economy.
As of 2021, according to the estimate provided by the U.S. Energy Information Administration (EIA), the global oil demand is peg at 98 million barrels per day. When the international price of oil increases, it decreases the demand in the continental United States. However, the demand from emerging markets and newly industrialized countries continue to rise as they need oil to fuel various industries supporting their economic growth.
Some countries provide fuel subsidies to their consumers, but these subsidies are not always beneficial to their economies. While subsidies drive the demand up, it could sometimes be bad for the country’s oil production. It could also negatively affect oil producers since they would be compelled to sell at a loss. Hence, removing fuel subsidies might actually allow a country to increase its overall oil production, translating to a bigger supply and lower price. Moreover, removing or cutting subsidies can solve shortages for oil refined products since higher prices give refineries financial leeway and an incentive to produce refined products, including gasoline and diesel.
Oil is a non-renewable resource which means it is limited and that we will run out of it someday. In 2020, the estimated total barrels of oil produced every day was 94.25 million. Though the demand for this global commodity continues to rise, finding new oil reserves is proved to be in decline. The number of newly discovered oil reserves has continued to fall since 2014. And this is partly because of the smaller budget for oil explorations triggered by the fall of the global oil prices.
Most countries in the Organization of the Petroleum Exporting Countries (OPE) cannot pump more oil than their current pace. However, Saudi Arabia is an exception as the Kingdom keeps an estimated spare capacity of around 1.5 to 2 million barrels per day. Saudi Arabia, along with the United States and Russia, are the top three world oil producers.
How to Invest in Oil?
If you plan to invest in oil, you do not need to relocate to oil-producing places or countries to start. In addition, you do not even need much money to have a stake in it because, contrary to popular belief, investing in oil does not require you to have lots of funds.
There are lots of ways on how a beginner can invest in this industry, and most of these do not require you to physically own oil and have a large sum of money. Some of the ways beginners can have a stake in the oil market are through investing in oil-related stocks, oil futures, oil mutual funds, and oil futures.
1. Oils Stocks
One of the ways of investing in oil is through stocks. Oil stocks are stocks of companies involved in the extraction and production of petroleum and other related products. However, you may want to research the company background, income, management, and other factors before buying its stocks. Moreover, remember that it is generally a good idea to invest in index funds and mutual funds instead of individual stocks since funds offer the diversification that is absent in individual stocks.
Furthermore, “oil companies” is a broad term. Companies may operate in different aspects of the industry, which means different revenue and standings. It would be good if you knew first the kind of “oil company” you will invest in.
Some of the types of companies involved in the oil market are:
· Upstream oil companies. These companies are engaged in the extraction and production of oil. They explore various locations in search of oil, and once they find one, they will drill wells to extract it. Among the types of oil companies, the upstream companies are the most susceptible to price fluctuations.
· Midstream companies. These companies manage the process, transport, and storage of crude oil and other petroleum products. Midstream companies work through fixed-rate, long-term, or take-or-pay contracts. Because of these, the profits of midstream companies are less affected by price fluctuations.
· Downstream companies. These companies are the ones that refine crude oil into products such as petrochemicals. Selling it to consumers is sometimes part of their business operation too. Downstream companies receive impact from price fluctuations.
· Integrated companies. These companies handle and operate two or more segments of the supply chain.
· Oilfield Services companies. These companies serve as partners of the upstream companies as they provide equipment, operational support, and other services. These equipment and support include drilling rigs, pressure valves, subsea robots, and others.
2. Oil Mutual Funds
Oil funds are a basket of stocks, and you buy them all at once when you invest in these funds. Oil funds like index funds and exchange-traded funds are generally safe since they provide enough diversification compare to investing in individual stocks. However, investing solely in a specific type of fund like an oil fund does not shield and cushion you from further market problems; thus, it is generally better in this scenario to invest in broad index funds.
3. Oil Futures
Oil futures are a more complex form of investment than stocks and funds, so investors should be cautious. Oil futures are a means for producers and buyers to lock the price of oil and related products in advance. Oil futures are contracts between two parties. These contracts stipulate the fixed amount of oil, its set price, and the set date to which the two parties agreed to exchange.
Is investing in oil expensive?
Investing in oil is a lot cheaper than what others are thinking. Oil investments are not only for the rich since there are many ways one can have a stake in it without investing a big chunk of their money. One such inexpensive method of investing in oil is through ETFs.
Is investing in oil safe?
Like other forms of investments, oil does not guarantee a 100% profit. All investments have risks; it is just that other forms of it are relatively and generally safer than the others. Investing in oil funds is considered to be a lot safer than investing in individual oil stocks since the former provides diversification. On the other hand, oil futures are investments considered to be riskier, so investors should be careful when dealing with them.