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How and Why to Invest in Oil

By Colin Dodds · June 15, 2021 · 4 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

How and Why to Invest in Oil

Investors look to oil for a number of reasons. It’s 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.

Read on to learn how to buy oil stocks, other ways that you can invest in this sector, and how oil compares to other types of investments.

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 .

Trends in Oil Investing

Oil prices plummeted in 2020, as the Covid-related lockdowns drove U.S. oil prices into negative territory for the first time in history. It happened on April 20, when investors bid the price for West Texas Intermediate (WTI) from $18 per barrel, down to roughly negative $37 a barrel.

As 2020 continued and a new normal emerged, oil prices came back from their April lows. And even with people around the world getting vaccinated, and more countries starting to reopen, oil investments face many questions.

There is deep uncertainty about the recovery prospects for the global economy as a whole, which makes it difficult to know how oil prices will perform. A forecast from the U.S. Energy Information Administration (EIA) suggests that oil prices will hold relatively steady from 2021-2022, at around $62 per barrel.

Forces That Drive Oil Prices

Covid is far from the only factor that impacts oil markets.

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 Russia and 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.

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

The volatility of oil and its importance to the global economy makes it an important asset class for many investors. So how do you buy crude oil stocks? One easy way is to open an account with a SoFi Invest® brokerage platform.

SoFi Invest offers an active investing solution that allows you to choose your stocks and ETFs without paying SoFi commissions. SoFi Invest also offers an automated investing solution that invests your money for you based on your goals and risk tolerance, without charging a SoFi management fee.

Photo credit: iStock/kckate16


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