Oil is valuable, and one of the most widely used and widely traded commodities in the world. Despite the growth of many forms of alternative energy, oil remains essential to the functioning of industry and transportation around the globe.
Given all the factors that go into oil prices, it’s no wonder that they can fluctuate dramatically, often on a daily basis. The price of oil has an impact on a wide range of industries, and ultimately on the prices that consumers pay at the pump, in the supermarket, and beyond. That also makes it attractive to investors.
Ways to Invest in Oil
For those who are interested in incorporating crude oil investing in their portfolio, there are many ways to get started.
Oil Company Stocks
In addition to the massive global names, there are other companies that specialize in different aspects of energy production, oil exploration, drilling, equipment, delivery and more. There are also smaller oil companies with vertical operations, but only in specific parts of the world. Each of those types of companies will perform differently depending on the many geopolitical, economic, technological, and other factors that drive the price of oil up and down.
Recommended: Investing in the Energy Sector: What Any Investor Should Know
Oil Funds
Not every investor has the time or interest to research a host of oil companies. For those investors, a better approach might be investing in a mutual fund or exchange-traded fund (ETF) that focuses on the oil sector, or more broadly on the energy sector.
Since thematic ETFs and mutual funds hold many securities, they offer investors a level of diversification within their portfolio.
Recommended: Key Differences between Mutual Funds and ETFs
Exchange-Traded Notes (ETNs)
Exchange-traded notes are a vehicle that invests directly in oil futures contracts. Investors like them because they offer easy access to oil futures, without some of the other factors that can affect the performance of oil companies, such as currency fluctuations and swings in the equity markets. Because they buy oil futures directly, ETNs can offer investors a more direct investment in the price of oil.
Derivatives
More sophisticated investors may also consider investing in the derivatives markets, buying futures, and options. Crude oil options trade on the New York Mercantile Exchange (NYMEX) and on the ICE exchange.
Alternative Investments
Investors interested in alternative investments might get exposure to oil by purchasing mineral rights or buying into Limited Partnerships (LPs) that invest throughout the sector.
💡 Quick Tip: All investments come with some degree of risk — and some are riskier than others. Before investing online, decide on your investment goals and how much risk you want to take.
Trends in Oil Investing
Oil prices plummeted in 2020, as pandemic-associated lockdowns drove U.S. oil prices into negative territory for the first time in history. In April 2020, investors bid the price for West Texas Intermediate (WTI) from $18 per barrel, down to roughly negative $37 a barrel.
Later that year, oil prices began to normalize. Demand returned in 2021, and oil prices shot back up in 2022, when they reached levels not seen in decades. In 2023, prices did fall a bit again — but the point is that prices are always on the move. Given the unpredictability of the global economy, too, it’s very difficult to determine how oil prices will perform going forward.
Forces That Drive Oil Prices
There are many factors that determine oil prices. That, in turn, can affect prices for gasoline and more. Here are some of the forces at play.
The Organization of Petroleum Exporting Countries (OPEC)
Another important contributor to oil prices is the Organization of Petroleum Exporting Countries (OPEC), a group of 13 oil-producing countries, including Algeria, Angola, Congo, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, the United Arab Emirates, and Venezuela.
Together, they’re responsible for nearly 80% of the planet’s oil supply. As an organization, OPEC meets regularly to set production levels. And its decisions can directly change the price of oil and gas. And while it has a massive influence on the price of oil, it doesn’t control the price.
Market Fundamentals
The global oil market is a force in its own right, as supply and demand tend to fluctuate sharply and unpredictably. There can be too much supply. Within OPEC, members don’t always follow through on the limits they agreed upon limits. There are also major oil suppliers, such as the United States, who are not OPEC members who may produce more oil than expected. That can cause high levels of supply relative to demand, which can drive down prices.
Production Costs
Oil in Canada’s oil sands or American shale reserves is far more labor-intensive and expensive to extract and refine than the oil in the Middle East. Those extraction costs contribute to the price of the oil, which can drive the oil prices higher or lower, depending on where the bulk of supply is coming from at any given time.
Natural Disasters
Oil prices are also susceptible to change as a result of natural disasters. Hurricanes, for example, regularly shut down oil production in the Gulf of Mexico, which can reduce the supply of oil and drive prices up.
International Relations
The headlines, especially international ones, can also drive oil prices. A significant amount of the world’s oil comes from the Middle East. Political instability in that region creates investor uncertainty, which can lead to price fluctuation. The same goes for countries like Russia, which produce a lot of oil, but as of 2023, are involved in geopolitical conflicts.
Economic Factors
While not always the case, recessions and economic turmoil can push oil prices lower.
The relative strength of the U.S. dollar also plays a role in the price of oil. The thinking is that a strong dollar allows American oil companies to buy more oil, and cut the cost to U.S. consumers, who buy 20% of the oil on the market.
However, while oil does not typically perform well during a recession, it does typically become more attractive to investors later in the business cycle.
The Takeaway
Oil is always in demand, and fluctuates a lot in price, which may make it attractive to many investors. But it’s a volatile investment, which can make investing in oil a risky endeavor. Given that many people are focused on renewable energy sources, too, investing in oil may not be as attractive as it once was.
The volatility of oil and its importance to the global economy makes it an important asset class for many investors. But again, it’s risky — so, whether you decide to invest in oil or oil-adjacent sectors and companies should be given considerable thought.
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