Crude oil, also known as petroleum, is extracted from the earth using big oil rigs. It is then refined through several processes for a litany of products. It is used to make plastics, rubber, fuel oils for heating and electricity generation, synthetic materials that are in just about everything we use (that you are probably not aware of…) and probably most importantly — transportation fuels. There are some basic things to know before you invest in oil.
Oil can be a lucrative industry to invest in since it essentially drives the economy (pun intended). Oil is a commodity that is essential to the global economy, as it provides energy as well as petroleum products that are used almost everywhere. You can invest directly in oil as a commodity, or indirectly through energy related equities, such as ETFs for example. You can trade via a broker or online brokerage, whatever your preferred method is.
What Is Oil: Is It An Asset?
Oil and petroleum are critical commodities for many nations globally due to their many uses, particularly in the energy sector. Several countries have large crude oil reserves that they have as an asset for future use. What exactly is oil, and why is there so much demand for it?
Products Of Oil And Petroleum
Crude oil is a hydrocarbon mixture that exists as a liquid in underground geological formations and remains a liquid even when brought to the earth’s surface. Oil and petroleum are terms that are often used interchangeably. Petroleum is a fairly broad category and includes both petroleum products as well as crude oil.
Petroleum products are produced in the following ways:
- From crude oil processing and other liquids at the petroleum refineries
- They extract the liquid hydrocarbons at the natural gas processing plants
- At blending facilities they produce finished petroleum products
One 42-gallon barrel of oil creates 45 gallons of petroleum (due to refining process gains). Of the 45 gallons of petroleum, 19.4 gallons of gasoline are produced, 12.5 gallons for distillate, 4.4 gallons for jet fuel and the rest is used for other petroleum based products. There are about 6,000 petroleum products that can be made, here are just few examples:
- Basketballs, footballs, golfballs
Supply and Demand
Similar to any other market, the crude oil industry is driven by supply and demand. When supply is greater than demand, those in possession of oil have an excess and therefore are more likely to sell it at cheaper prices. Conversely, when demand is higher than supply, oil will be sold at higher prices.
Currently there is no suitable substitute for petroleum based products. This in turn makes the entire global economy highly reliant on the product. The world relies heavily on the supply of oil and petroleum since there is no substitute to create all of the products that we use everyday.
Demand is so high and there is physically a limited supply, obviously, since it is not a renewable resource. This makes it a very desirable commodity. We will eventually get to a point where global supply is not able to keep up with the demand, which will cause the future price of oil to rise. When the price of a barrel of oil goes up this has a ripple effect, for example, gas prices go up and by proxy so do the shareholder’s investments as well.
While there are other market forces impacting the price, the biggest influencer is the Organization of the Petroleum Exporting Countries (OPEC) who controls 40% of the world’s oil supply and has a major part in influencing oil production as well as the price of oil (Algeria, Angola, Congo, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, United Arab Emirates and Venezuela).
How Can I Get Started Investing In Oil?
How can I get started investing in oil and petroleum type businesses? The more important question you should ask yourself is “should I be investing in oil”? There are both risks and rewards that you should consider prior to proceeding. Plus there is a higher cost threshold than typical investing. If you decide to invest in oil, is there a way you are able to invest with only a little bit of money?
Should I Invest In Oil?
With the global economy so heavily reliant on the oil and petroleum industry, it is probably fair to say you should invest in it. This is only if you are comfortable with the risks mentioned. The oil industry is at times very volatile and there is a risk that you can lose money certainly, but there is also a high chance of making a lot of money. You should try to educate yourself on ways to minimize risk and increase profitability opportunities.
How To Invest With Little Money
With the oil industry, there may be a high barrier of entry when it comes to investing financially depending on the type of investment. However, there are still a few ways you can get started if you don’t have much starting capital. If you are considering investing in the oil and petroleum industry, here are some direct and indirect methods to do so:
- Oil Stocks: You can use a brokerage and directly invest any amount you choose in any oil or petroleum company that you desire. For example, you can buy stock from companies such as Exxon Mobil Corp., Chevron Corp, Marathon Petroleum Corp, etc.
- Mutual Funds & ETFs: The most common method of investment for the average investor is to buy oil ETFs or mutual funds. ETFs and mutual funds offer a portfolio that is a diversification of oil and petroleum based companies. ETFs can be bought and sold similar to stocks on exchanges, whereas mutual funds do not offer intraday trading
- Options and Futures: The most popular futures on the market may be oil futures contracts. These kinds are very accessible and liquid. Futures can be highly volatile and typically include a great deal of risk
- Master Limited Partnership (MLP): A business venture that exists in the form of a publicly traded limited partnership. MLPs combine the liquidity of a publicly traded company with the tax benefits of private partnerships. Only when investors receive any distributions are the profits taxed
Are Oil And Petroleum Good Investments?
Oil and petroleum investments can be a great investment vehicle. They also are susceptible to many factors that influence the value. Some of the top factors when determining the benefits and drawbacks of oil investments are as follows.
Pros Of Oil Investing
Oil and petroleum investing can be quite advantageous if you invest wisely. You have a possibility to make a lot of money, since this commodity has its fingerprint almost everywhere globally. The main pros for a oil investing are:
- Lucrative Investment: The world economy in a way revolves around oil and gas consumption, with population growth the consumption is expected to also increase
- High Returns on Investments: As demand increases for oil and petroleum based products and the supply constantly diminishing, returns are and will be expected to be increasing
- Tax Incentives: Investing in the energy sector offers many tax benefits. The US government encourages investments into this sector and offers incentives to do so in the form of tax incentives
Cons Of Oil Investing
There are many influencing factors that can determine the value of oil at any given time. A lot of these factors provide uncertainty in the market, and therefore can provide a volatile setting for your investments. The main cons for a oil investing are:
- Market Volatility: Oil and petroleum are subjected to operational costs, which in turn impact the market price (Operational costs include drilling difficulties, retaining qualified employees, issues with the fracking process, etc.)
- Politic Influence: Around the world, there are many political decisions that influence oil prices (trade policies, tax reforms, etc. all impact oil pricing)
- Environmental Uncertainty: Oil prices are definitely susceptible to inclimate weather such as hurricanes or other natural disasters that may impact or halt oil production
Consider Guidance From A Financial Advisor
The energy sector can be complicated, as there are a lot of factors that influence the value of a company’s stock that could be out of the company’s hands. Luckily, investing in the oil market means that you have a wide array of options you can choose from. You may have questions regarding how to start investing in the oil industry. If you want to know how to get started. Or if it is a good investment, you should contact a financial advisor for professional advice.