By Amir Shalev | Last update: 5/4/2023
How to invest in Oil – TL;DR:
Investing in oil can be done through several methods, including purchasing stocks of oil companies, buying shares of exchange-traded funds (ETFs) that track the performance of the oil industry, or investing directly in futures contracts or options contracts for crude oil. It is important to do thorough research on the specific investment options and to consider factors such as market trends, geopolitical events, and supply and demand dynamics when making investment decisions. As with any investment, it is important to carefully consider one’s financial goals and risk tolerance before investing in oil.
How to invest in oil?
Our belief that deficit spending and its funding through currency creation will lead to inflation has led us to explore investment in gold. We think the case for oil is also quite strong, for the same reasons, coupled with years of lack of investments in oil exploration and production (E&P). We now have a favorable environment for oil investing.
There’s different options for investing in oil, including oil futures, crude oil ETFs, and oil E&P stocks.
Trading Oil Futures
Those looking to invest in oil will probably find out that buying physical barrels of oil and storing them in a warehouse is not a viable option for most of us. And so, we would often end up looking at oil futures investing. So what are oil futures?
Oil futures are contracts that allow you to buy or sell oil at a specific price at a specific date in the future. These contracts are traded on exchanges such as the New York Mercantile Exchange (NYMEX) or the Intercontinental Exchange (ICE). To trade oil futures, you’ll need to create an account with an online broker like TD Ameritrade, E*TRADE, or Interactive Brokers. After depositing funds, search for oil futures contracts, which often have symbols like “CL” for crude oil.
Futures contracts are standardized, with a specific contract size, expiration date, and trading hours. For example, the standard crude oil futures contract on NYMEX represents 1,000 barrels of oil, with monthly expiration dates. Prices are quoted in dollars per barrel, and the minimum price fluctuation is $0.01 per barrel.
Keep in mind that futures trading can be risky and requires a good understanding of the market. It’s crucial to research and learn about futures trading before diving in. Familiarize yourself with concepts like margin requirements, leverage, and the different types of futures orders (e.g., market, limit, stop).
Contango and Backwardation in Oil Futures Markets
Contango and backwardation are important concepts in the futures markets. Contango occurs when the more distant futures price (back month) is higher than the expected spot price and front month (the closest expiration date contract). In contrast, Backwardation occurs when the back month futures price is lower than the expected expiration spot price or front month. Experienced traders use contango and backwardation as indications for market “tightness”, usually a strong front month Backwardation, implies strong demand in the physical market and is viewed as a “Bullish” signal.
Contango and backwardation can impact the performance of crude oil ETFs. Specifically, contango can create a negative roll yield, which occurs when an ETF must sell expiring futures contracts and buy more expensive ones to maintain exposure to oil prices. This can lead to underperformance compared to the actual price of oil. In contrast, backwardation can create a positive roll yield, potentially boosting the ETF’s performance.
Because trading oil futures and oil futures investment requires learning and some more advanced trading skills, beginners would often start by looking at Exchange Traded Funds (ETFs or ETNs) that offer exposure to oil. We will cover them below.
Investing in Crude Oil ETFs
A simpler method for investing in oil is through crude oil ETFs. These funds track the price of oil and can be traded like stocks. However, the investment methodology of these funds is done through holding different future contracts and constantly rolling them over. In that sense the structure of the futures curve (contango or backwardation) can influence your investment results.
Consider the United States Oil Fund (USO), This is perhaps one of the most popular oil investment vehicles for beginners. The fund holds the next 2 months oil futures, while as the front month gets closer to expiration, the fund needs to constantly sell the contracts closer to expiration while buying new contracts in the back month. This term is called “Rolling” and the financial effect could be positive or negative. When the oil market is in contango, the fund is in fact selling a contract at low price, and buying a future contract at a higher price, over and over again. This is called “negative roll yield”, and could be devastating for you as an investor. The chart below shows prices over 5 years for WTI oil (black), USO (red), and USL (green, an ETF that holds 12 months of futures).
- WTI spot, USO, USL over 5 years
As can be seen in the chart above, an investor who bought USO as a way to express his bullishness on oil prices would have suffered >40% losses, even though in absolute terms, oil itself has increased in price. Worthwhile to note the relative over performance of USL due to its holding structure of farther away months. USL will not provide the same explosive performance when spot oil prices rise quickly, but may be a good option to explore for longer term holding.
Crude Oil Companies ETFs
Crude oil E&P (Exploration and Production) companies ETFs are funds that invest in oil exploration and production companies. These ETFs provide exposure to the oil industry without having to invest in individual stocks. Examples of E&P ETFs include the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) and the iShares U.S. Oil & Gas Exploration & Production ETF (IEO). By investing in a diverse array of companies, these ETFs can mitigate the risks associated with individual stocks, such as company-specific news or financial difficulties.
Investing in Oil E&P Stocks
Another option is investing in individual oil E&P stocks. You may want to read our report on the best oil stocks. Some major oil companies to consider are Exxon Mobil (XOM), Chevron (CVX), Canadian Natural Resources (CNQ), and MEG Energy Corp (MEG). When investing in these stocks, research each company’s financial health, production capabilities, and growth potential.
Exxon Mobil (XOM) is one of the largest oil companies in the world, with a diversified portfolio of assets across exploration, production, and refining. The company has a strong balance sheet and a history of returning capital to shareholders through dividends and share buybacks.
Chevron (CVX) is another major player in the oil industry, with a focus on both upstream and downstream operations. The company has a reputation for operational efficiency and capital discipline, making it a potentially attractive investment for those seeking exposure to the oil sector.
Canadian Natural Resources (CNQ) is a leading independent oil and gas producer with a diversified asset base, including operations in North America, the North Sea, and offshore Africa. CNQ has a strong production growth profile and a commitment to maintaining a healthy balance sheet.
MEG Energy Corp (MEG) is a Canadian oil sands company with significant bitumen production and growth potential. MEG has implemented innovative technologies to improve efficiency and reduce costs, making it a compelling choice for investors interested in the oil sands sector.
Investing in oil companies involves researching companies in the oil industry and assessing their financial performance, growth prospects, and dividend history. Additionally, evaluate factors like reserves (Proved Developed Producing (PDP), Proved Undeveloped (PUD), etc.), production costs, and the percentage of liquids vs. gas, and how these factors evolve over time. After selecting companies to invest in, open an account with an online brokerage, deposit funds, and purchase shares of the chosen oil companies.
6. FAQs
Is it a good idea to invest in oil?
Yes, due to the lack of investments in oil E&P and expected inflation, oil investing can be a good opportunity. However, it’s essential to carefully consider the various investment options and weigh the risks and potential rewards.
Can I buy oil in stocks?
Yes, you can invest in oil-related stocks, such as oil E&P companies and crude oil ETFs. as we explained above.
How to invest in oil wells?
While most people would not be able to directly partner with an oil drilling company, you could explore investing in a mutual fund or ETF that focuses on oil drilling and well operations. Some examples include the VanEck Vectors Oil Services ETF (OIH) or the Invesco Dynamic Energy Exploration & Production ETF (PXE).
How to invest in oil stocks?
To invest in oil stocks, research individual companies in the oil sector, paying attention to financial health, production capabilities, and growth potential. It is important to understand the reserves’ life, produciton costs and quality of the assets. once done, create an account with an online brokerage, deposit funds, and purchase the desired stocks.
How to invest in oil companies?
Investing in oil companies involves researching companies in the oil industry and assessing their financial performance, growth prospects, and dividend history. Additionally, evaluate factors like reserves (Proved Developed Producing (PDP), Proved Undeveloped (PUD), etc.), production costs, and the percentage of liquids vs. gas, and how these factors evolve over time. After selecting companies to invest in, open an account with an online brokerage, deposit funds, and purchase shares of the chosen oil companies.
How to invest in oil ETFs?
To invest in oil ETFs, research the different funds available, such as crude oil ETFs or oil E&P ETFs. Consider the effects of contango and backwardation that could create long term losses on ETFs such as USO. Once you’ve chosen an ETF, create an account with an online brokerage, deposit funds, and purchase shares of the chosen oil ETF.
How to invest in oil drilling?
Investing in oil drilling can be done by purchasing stocks of companies involved in drilling operations or by investing in ETFs or mutual funds focused on the oil services sector. The oil services sector includes companies that provide drilling, well completion, and other support services to oil and gas producers. Examples of oil drilling companies include Schlumberger (SLB), Halliburton (HAL), and Baker Hughes (BKR). Research companies and funds with strong exposure to drilling activities and evaluate their financial performance and growth prospects.
How to invest in oil rigs?
The future of offshore drilling could present an interesting investment opportunity. Investing in oil rigs can be achieved by purchasing stocks of companies that own and operate oil rigs or by investing in ETFs or mutual funds that focus on the oil services sector such as the VanEck Vectors Oil Services ETF (OIH) . Research the companies and funds with exposure to oil rig operations and consider their financial performance, growth potential, and the overall state of the oil services industry. Examples of companies that own and operate oil rigs include Transocean (RIG), Diamond Offshore Drilling (DO), and Noble Energy (NE).