All You Need to Know About Oil Investment Opportunities
Although the idea of investing in oil is enough to make some investors nervous, there are a variety of options available to choose from if you do choose to invest in the oil market.
Ways of Investing in Oil
There is a broad variety of options to choose from in the oil market. You can explore the likes of mutual funds, exchange-traded funds (ETFs), futures, and oil stocks. It may seem overwhelming when it comes down to deciding how to invest in oil and what asset to buy. Below we take a look at each oil investment opportunity available to investors in this market. They include:
- Mutual Funds or ETFs: You can purchase shares in a number of oil focused mutual funds or ETFs. These will help you gain substantial exposure to oil without even having to take on the risks of commodity spot prices. Furthermore, you avoid the risks of putting your investment capital in any one oil company.
- Large Cap Stocks or ADRs (American Depositary Receipts): Another popular way of gaining exposure in the oil market is via publicly traded companies. You can purchase oil stocks from variety of companies. Some of the best oil stocks are from companies such as British Petroleum, Chevron, Royal Dutch Shell, Anadarko Petroleum Corporation, Marathon Oil, among others. Each of these companies engage in oil exploration. Therefore, you can invest in them directly via shares or ADRs.
- Future Contracts: You can purchase derivatives such as oil futures contracts. However, these can be extremely risky as they expire frequently without any worth.
- Small/ Micro-Cap Stocks and Limited Partnerships: This is a more specialized field of investing. If you still want to make a direct investment in the oil market, you can purchase into small or micro-cap stocks or a limited partnership focused on oil. If the company is not publicly traded, you may want to engage the services of a broker. Alternatively, you can deal with the company’s management directly for a more private placement opportunity.
The Pros and Cons of Investing in Oil
- Potential for Profit: Investing in oil wells can occasionally pay well, especially if the well generates a lot of oil. It can reciprocate to well-paying dividends over many years.
- Diversification: Oil is a useful portfolio diversifier especially against the economy. For instance, when oil prices rise, the economy tends to slow down- a major cause for stocks to stumble. However, when oil prices rise, stocks tend to rise with them. Thus, an exposure to oil stocks can help protect your portfolio from economic slowdowns caused by oil.
- Tax Advantages: There is some tax advantage to investing in oil. For instance, the IRS allows for deduct for depletion. This is a way of accounting that accounts for the global gradual exhaustion of mineral supplies in a plot of land. It’s especially important if you buy a membership in a limited partnership. Deduct for depletion can be the difference between a property that loses money and one that’s cash flow positive.
- Volatility: Oil investments are particularly subject to wild price swings. Therefore, there’s a significant risk of losing a great amount of money. In fact, losses of about 50% are not unusual.
- Liquidity: Don’t invest in non-publicly traded companies or limited partnerships if you are not willing to tie up your money for a while. This is because it’s usually challenging to find a buyer for shares of smaller companies. In extreme cases, you may have to redeem your interest with the company that you invested in directly.
- Commissions: Limited partnerships or closely held corporations expect that you pay a commission to a broker or intermediary to buy into them. These commissions are often larger than those of standard stock-broker commissions. They can exceed even 20% for extremely illiquid companies. Therefore, money taken as commission isn’t put to work for you.
- Complexities: Oil investing comes with its fair share of complexities that aren’t for everyone. For instance, there are special tax rules that govern oil investments and rules specific to limited partnerships that can affect you, especially as you file or account for shares when you sell them.
Oil investments are highly volatile. Therefore, it’s important that weigh in the risks and benefits of investing in oil. These investments are highly risky, but they also yield greater returns on investments. It’s important that you understand the potential risks involved and be honest with your risk tolerance. If you are a novice investor, it’s wise to stick to what you know until you have a security blanket to fall back to in instances of severe losses.