With all the talk about the worldwide energy transition away from fossil fuels, you could be forgiven for thinking that global oil demand is on the decline.
That’s not the case. Various estimates say oil demand won’t start waning until slightly before 2030, sometime during that decade or even perhaps out until the mid-2040s. All agree that oil demand will increase in coming years.
“Despite green energy taking center stage, oil remains a global commodity used in more volume than ever and currently presents a high-margin, high-yield opportunity,” said Matt Willer, managing director with Phoenix Capital Group Holdings, an oil and gas mineral rights investment firm.
For investors wanting to dive into a risky market, this primer offers an overview of how to invest in oil.
Understanding the oil markets
The oil market is global and subject to supply and demand factors, geopolitical considerations and government actions. It’s important to understand that, like other commodities, oil prices are quite volatile.
What is crude oil?
Crude oil is a fossil fuel like natural gas and coal. It’s a hydrocarbon that formed over millions of years as sand, silt and rock covered the remains of animals and plants that lived before the dinosaurs.
Companies in the oil supply chain extract crude oil from the ground, transport it and refine it for use in many products on which the economy is based — automobile and aircraft fuel, heating oil, asphalt, lubricants, plastics and solvents.
“Oil plays a critical role in providing low-cost energy and in doing so helps drive growth and improved living standards,” said Geoff King, portfolio manager at Macquarie Asset Management. “Its uses, from pharmaceuticals to plastics, weave through our everyday lives beyond what most people imagine.”
Different ways to invest in oil
There are multiple ways to invest in oil, with different levels of suitability depending on investor sophistication, risk tolerance and buy-in ability.
Avenues include buying stocks of oil and gas companies, such as producers, refiners and master limited partnerships (MLPs).
Mutual funds and exchange traded funds (ETFs) can make this process easier by wrapping multiple stocks into one pooled investment.
Some funds also offer exposure to oil futures, and this can be an easier way for retail investors to go rather than dealing with the complications of trading futures directly.
“If I want a low-cost, diverse way to have energy exposure, I’ll buy an ETF, but if I’m looking for yield, I may buy best-of-class high dividend-payers,” Willer said. “If I’m hedging, I might look into options or futures, but it’s all predicated on the initial objective.”
Stocks
Oil producers like Exxon Mobil (XOM), Chevron (CVX) and Shell (SHEL) are household names.
They are vertically integrated companies, meaning they are involved in the oil supply chain from exploration, production, refining, transportation, marketing and sales to end users. In addition to stock price appreciation, investors can also earn money with these companies through their dividends.
Other ways to invest in oil stocks are companies that focus on just part of the supply chain, such as exploration and production companies, or MLPs, which are tax-advantaged and yield-focused infrastructure companies that issue exchange-traded units that function essentially as stock shares.
“Investing in oil through equities gives investors exposure to oil as a commodity while also providing the opportunity to benefit from a management team’s expertise in allocating capital across existing assets, new assets or through a return of capital,” King said.
Mutual funds and exchange-traded funds
To help minimize company-specific risks, investors can consider mutual funds or ETFs that bundle many different equities together under one ticker symbol.
Mutual funds that contain oil companies include the Vanguard Energy Fund Investor Shares (VGENX) and the Integrity Mid-North American Resources Fund (ICPAX), while ETFs include the Energy Select Sector SPDR Fund (XLE) and the Vanguard Energy ETF (VDE).
Beyond equities, there are ETFs that invest in oil futures, such as the United States Oil Fund (USO). It tracks the performance of near-month or next-month West Texas Intermediate (WTI) crude contracts.
Futures
Those funds that hold futures contracts can be bought and sold on an exchange like stocks, which makes them easier for investors to deal with than buying futures themselves.
Oil futures are contracts to buy or sell the commodity at a certain price at a certain time in the future. Trading them is complex and isn’t for the faint of heart. There is a big learning curve that includes the use of margin, leverage and rolling over contracts.
Benefits of investing in oil
A key benefit to investing directly in oil through futures is the potential for price appreciation. If the price of oil rises, the futures contract holder makes money. These assets can serve as a useful inflation hedge when the economy is running hot.
This price gain also benefits oil equity and futures funds as well as individual companies.
Dividends and corporate share buybacks are benefits for investors holding stock in oil companies. In recent years, oil companies have become more focused on returning capital to shareholders with repurchases and dividend payouts, easing back on drilling that can be expensive and cause the price of oil to fall due to increased supply.
Oil stocks can also outperform the price of oil, as corporate efficiencies can increase cash flow even if oil prices remain still.
Risks of investing in oil
Beyond the risks associated with trading oil futures contracts, there are also company-specific risks, such as poor management decisions, overpaying for an acquisition or going over budget with exploration projects.
And oil prices could decline for a host of reasons, including deteriorating macroeconomic forecasts, increased production by the Organization of the Petroleum Exporting Countries (OPEC) and its allies or easing tensions in the Middle East. There is also the risk that economies may wean themselves from oil faster than expected.
“In the shorter term, the main risk to investing in oil is buying at the wrong time in the cycle, where supply is increasing or demand is decreasing,” King said. “Longer term, some investors believe that oil will play a less significant role in our economies as alternative sources of energy increase, and oil could see structurally lower demand.”
| Pros | Cons |
|---|---|
Many investment options for different types of investors | Oil prices are volatile and subject to changes, or expected changes, in supply and demand |
Oil stocks often pay high dividends | Oil futures contracts and ETFs that own oil futures are complex investments |
Distributions from MLPs are tax-advantaged | Oil companies are subject to financial and management risks |
Energy assets may act as an inflation hedge and add portfolio diversification | Macroeconomic conditions, geopolitical tensions and government actions can negatively impact oil prices |
Oil stocks have a low barrier to entry for individual investors | Adoption of renewable energy sources may pose a risk to oil demand |
Sustainable alternatives to oil investment
Investors who may be concerned with the ethics of investing in oil companies amid climate change, or those who just want to diversify their energy holdings, can consider investing in renewable energy companies.
These include solar, wind, geothermal and biomass companies, as well as those involved with batteries, green hydrogen and clean energy technology. Green energy alternatives can serve as a hedge against oil demand eventually declining. Also, alternative energy companies can increase in value along with oil prices because more expensive oil makes their products more attractive.
Solar and wind companies have struggled recently as high interest rates have made borrowing money for their large capital expenditure projects more expensive.
“An investor could access the energy theme in a variety of ways, including investing in renewable energy companies,” King said. “However, since many of these companies are exploring complex or new technologies, these investments can carry a greater risk.”
Frequently asked questions (FAQs)
There’s no hard-and-fast minimum amount of money needed to invest in oil.
Some oil company stock prices can provide relatively easy entry points and a way to invest in oil with little money. Shares of Occidental Petroleum (OXY), a favorite of billionaire investor Warren Buffett, traded at a little over $62 as of the market close on March 13, 2024. Pipeline company Enbridge (ENB) was around $36 per share.
Other types of oil investments might have minimum requirements. Some futures brokers might have a minimum deposit of $500, while others may require thousands. There may also be a minimum investment in mutual funds, such as the $3,000 required for the Vanguard Energy Fund mentioned above.
“While no minimum investment exists, starting small and gaining experience may be beneficial,” said Alexey Efimov, market analyst at online trading broker Alpari.
Factors affecting the price of oil investments include supply and demand, or expectations of changes in supply and demand.
For example, if experts think the global economy is headed toward a recession, oil prices might falter substantially. The idea is that a slowdown in the global economy will result in less economic activity and lower demand for oil products.
But if major oil-producing nations, including OPEC, decide to curtail supply, that could help stabilize prices or maybe even move them higher.
Geopolitics, such as tensions in the Middle East involving major oil producers, can also swing global oil markets.
Government actions involving taxes, subsidies and environmental regulations can also affect the price of oil, as can policies that support renewable energy.
“Over time, oil investments have been subject to new methods of extraction, wars, embargoes, swings in production and questions around the product’s ultimate viability,” King said.
