How to start investing in oil and oil stocks

Oil is one of those investments that has its own mystique, conjuring images of oil barons prospecting for the Black Gold.

The reality is more mundane, and oil stock are no more likely to make you rich than any other class of assets or alternative investments.

Additionally, there are growing ethical concerns with oil investments due to the rising risk of accelerating climate change.

Because oil prices are highly volatile (and therefore high risk), they do have the potential for delivering large short-term gains if you’re lucky, or big losses (if you’re not).

There are many ways to invest in oil, including direct and indirect investments.

Find out more about how to start investing in oil and whether it's the right option for you below.

What affects the price of oil?

Oil stocks are highly sensitive to changes in global supply and demand.

If demand is high or supply decreases, oil prices will rise. If new reserves are discovered or demand falls, prices will drop.

Geopolitical events like the Covid-19 pandemic, Brexit, the Russia-Saudi price war, and changes in global macroeconomic activity can also drive the price up or down.

The Organization of the Petroleum Exporting Countries (OPEC) is an international organisation set up to try to keep oil prices relatively stable and fair.

Its member countries control around 75% of the world’s crude oil reserves and produce 42% of global crude oil output.

The OPEC remains the primary driver of oil prices, but the US (as the largest oil-producing nation) is enjoying a resurgence due to new shale oil reserves and is challenging its domination of the sector.

Is investing in oil right for me?

Anyone considering oil as a potential investment should especially consider these factors:

• Volatility: the oil price can rise and fall rapidly
• Ethics: investing in fossil fuels will not suit those looking for green investments
• Complexity: you will need to be an experienced investor

Oil is not a good option for highly risk-averse investors.

As well as price fluctuations and sensitivity to economic, political and diplomatic events, accidents like oil spills can also negatively impact stock prices, due to costly clean-ups and legal consequences. Also it will not suit those looking for ethical investments.

On the other hand, the world’s largest economies rely on fossil fuels, and oil in particular.

Despite the global trend towards renewable energy sources, fossil fuels are estimated to provide a large share of our global energy, although their share of global energy generation is projected to fall to 54% by 2026.

The demand for oil investment is, therefore, likely to linger for some time, although it should be noted this demand is falling considerably on a global scale, posing notable investment risks. The level of sophistication in oil trading should also not be underestimated.

Though people talk about ‘the price of oil,’ there is, in fact, no single oil price. Unlike, say, gold or platinum, oil is not just one asset but over 150 different oil blends and indices, all of which can rise and fall in price independently (though there is often a correlation between these fluctuations).

As such, trading in oil is often more like trading in shares than it is like trading in commodities.

If you are already an experienced investor in stocks and shares and want to explore new challenges, and the ethical angle does not deter you, then oil stocks could well enhance your portfolio.

A typical use for them might be in the small ‘high risk’ slice of your portfolio, where you can generate strong returns without putting too much of your capital in jeopardy. You could also consider oil stocks as part of a self-invested personal pension (SIPP).

Which is the best investment option for oil?

There are a number of different ways to invest in oil.

Each option has its pros and cons.

Indirect investment

You can invest in oil indirectly by purchasing shares in oil companies, such as Exxon Mobil or BP.

This strategy is the most accessible for experienced investors, as it’s the same process as buying shares in any sector.

If oil prices are low and you’ve got the patience for a long-term investment, buying into an oil company could be a less hair-raising ride.

Commodity-based oil ETFs

Exchange-traded funds (ETFs), are a way of buying direct shares in a single type of oil, like Brent Crude oil.

They’re bought and sold in a similar way to stocks but are traded on their own stock exchange.

These products fluctuate in price throughout the day as they’re sold and bought, as they do not have a set trading window. This means they can be useful assets if you’re looking for a shorter term or liquid investment.

Energy sector ETFs

You can also invest in an ETF that covers a number of different energy commodities, such as natural gas and heating oil.

Choosing an ETF with a broader focus may offer more protection from market volatility, but it’s still riskier than traditional shares.

Oil futures

Investing in oil ‘futures’ is the riskiest strategy and requires you to have significant capital.

Essentially, a buyer will agree to purchase oil stocks at a later date for a set price when the ‘futures contract’ expires.

The price they agree to could be very different from the current market price, as it uses a complex model to predict future cost.

This can lead to huge wins or losses for the buyer or seller when the price inevitably shifts in one’s favour. Essentially, it’s gambling.

Oil options

An option gives you the chance to buy or sell oil at an agreed price.

Unlike a futures contract, there’s no obligation to go through with the transaction, making it less risky.

All you need to do is decide by the expiration date if you’d like to go ahead. To give yourself the luxury of backing out, you will generally have to pay a premium.

Should I use a stockbroker or a financial adviser for oil investing?

You may need help from both a financial adviser and a specialist oil broker or stockbroker to give yourself the best chance of success as an oil investor.

Financial advisers are generally not stock-pickers and will not advise you on particular stocks or shares. They will, however, help you understand how much risk you can afford to take, and, therefore, how much of your money you can reasonably speculate on the oil markets.

An oil broker or specialist stockbroker can give you more in-depth tips on the investment itself. However, remember, a stockbroker is not bound to act in your best interests, unlike a financial adviser, who is.

How do I invest in oil?

There are many ways to invest in oil.

You can do it yourself using a trading account (or an investing app), which can be opened online with a number of stockbroking companies. This option is best suited to experienced investors who understand the oil market and understand the complex factors that can quickly alter its price.

If you feel confident enough to look into futures and options contracts, this may suit you best.

However, if you’re new to the world of investment or have never invested in oil, ask a financial adviser about the best vehicle for you.

Remember that however you approach your investment, returns aren’t guaranteed, and you may lose more than you invest.

Nevertheless, a skilled financial adviser can help you ensure that you don’t take more risk than you are able to tolerate, and design your investments in line with your overall financial goals.

Get expert financial advice

Although oil stocks have a longstanding reputation for generating significant returns, they carry a high degree of risk, as well as growing ethical concerns regarding the use of fossil fuels and their proven contributions towards accelerating climate change.

Oil stock prices are highly volatile, and while they do have the potential to deliver notable gains in the short term, you may also be risking your capital on an investment that will not pay off in the long run.

Unbiased will match you with an expert financial adviser who can help you assess your risk tolerance, ethical stance, and capital availability to determine whether investing in oil is right for you.

If you found this article interesting, you might also find our article on pension vs property investments and the best mining companies to invest in informative, too.