A Beginner’s Guide to Oil Investment Options
Are you considering oil investment? This market can be overwhelming and confusing for beginner investors due to the surprising price fluctuations.
The price of this commodity is mainly determined by supply and demand, as well as geopolitics. Given supply is determined by the largest oil-producing countries, a conflict or war in these regions would affect the inventories of crude, and the price will keep on soaring. The Russia-Ukraine war taking place now is responsible for soaring oil prices.
The following beginner’s guide to oil investment options will be of assistance to aspiring investors.
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Spot and futures contracts
The most traditional investment option is investing directly in crude, which is mainly achieved through futures and spot contracts. This method involves an immediate delivery of physical oil, which isn’t very convenient for individual investors because of their lack of storage containers. Therefore, most investors opt for futures contracts.
Different from spot contracts, which enable investors to purchase this commodity at the momentary market price, futures represent an agreement between two parties to trade a given amount of such fuel at a previously set price on a predetermined date. In the process of trading futures, individuals are actually trading the contract, not the commodity.
In case the oil price goes up, the value of the contract increases as well. Consequently, the owner of the contract can sell it and make a profit. If the price goes down, the contract could become less valuable, meaning the owner might lose money upon selling it. The idea behind the trading of futures is for investors never to end up with the oil. There are usually plenty of buyers that are willing to purchase your futures contract once you decide to sell it.
Nevertheless, this market sustained a collapse back in 2020 in spring due to the COVID-19 pandemic, when investors couldn’t find buyers for their contractors for the first time in years. Anyhow, they rebounded pretty quickly. While trading futures can prove extremely lucrative, there are many risks to consider as well. Click here to see some tips for investing in oil.
Even though there are fair opportunities for earning high returns, the same goes for sustaining high losses if not being cautious. The futures market can sustain a significant blow due to unpredictable events, such as the start of the pandemic in April 2020.
Since the demand for fuel minimized during this period, futures investors faced difficulties in finding a buyer. The prices kept on falling until they went negative for a temporary period. Every investor should be aware of the possibility of black swan events taking place.
Stocks
Another option to consider is making an investment in oil stocks. These stocks can be classified into several categories, ranging from upstream to service stocks. These are actually shares of different companies involved in the production and extraction of petroleum. For instance, the upstream sector is also popular as exploration and production. These companies look for oil all around the globe.
By making a purchase of the exploration rights, they have chances of making huge returns. Upon finding oil, they need to extract it from under the surface. Nevertheless, these companies sometimes purchase exploration rights even if no discovery is made. These stocks are under the tremendous influence of oil prices. The following link, https://www.cnbc.com/2018/05/15/what-drives-oil-prices.html, elaborates on the factors that drive the price of oil.
Midstream companies, as the name implies, place their focus on the middle part of the supply chain, which refers to the transport and storage of petroleum after its discovery. Transportation of refined products is conducted as well. Due to the fixed contracts, midstream companies are capable of avoiding price volatility.
Downstream companies, on the other hand, sell oil-based goods to customers or refine crude into everyday goods. As a result, downstream stocks are under a huge impact on petroleum prices. Other companies affected by these changes in cost are the integrated companies, which combine a few of the above-mentioned categories.
Prior to investing in a particular company, you should conduct detailed research on the company’s past success. Pay special attention to their financials. Keep in mind that selecting either one or two individual stocks might result in a lack of portfolio diversification.
ETFs
Investors who aren’t interested in investing in individual stocks should consider investing in oil-focused ETFs (exchange-traded funds.) ETFs actually represent a stock collection that investors can purchase at once. Such funds are offered either by financial institutions or investment banks. Investing in an oil-based exchange-traded fund is the recommended solution for individuals specifically interested in this commodity.
In addition, such ETFs are the quickest and the most reliable way for diversifying petroleum investments. For example, there are certain ETFs that hold as many as 90 different stocks. Some exchange-traded funds pay dividends to capitalists. Despite being lower than in the case of individual stocks, these dividends can offer cash flow every three months.
Are these investments safe?
Just like any other investment, oil investments come with a certain level of risk, depending on the method you choose. For instance, investing in mutual funds is believed to be safer than investing in individual stocks, as the former option allows better diversification. Futures are undoubtedly considered the riskiest.
The bottom line
Be cautious when choosing the right oil investment by assessing the potential level of risk.
Futures are too risky for beginner investors!
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