Ways To Invest In The Eventual Rise In Oil Prices
First, let’s review the case for higher oil prices. Oil touches about everything in the world economy. It’s impossible to list all the items made from petroleum. But if you look around your home or office, about everything you see has petroleum in it. If you find something that doesn’t have petroleum in it. Oil is the air and water of our economy. Without oil, the economy can’t function, like living beings fail to function without air. The main reason that oil prices have dropped is very simple; we have more supply than demand at the moment. This supply was also caused by the slowing global economy. The advancement in technologies and the unwillingness of OPEC to cut production. According to the International Energy Agency, imbalance of supply and demand will continue.
As the oil price has declined well below the Mendoza line of profitability. many of the oil-related companies have gone into survival mode, and of course, some will fail to survive. The profitability line is different in each country. Based on how the oil extracted, but many oil producers need the oil to be above the $50-60 range to be profitable. The advancement in technology is making it possible for profitability to drop lower.
Over the last year or two, the number of holes drilled into the ground in the U.S. has dropped. And this will likely continue until it makes financial sense to drill again. The lack of new exploration will have an effect on supplies. And the supply issues will not be solved overnight, because of the time it takes to get production ramped up. This imbalance of supply and demand will change and the price trend of oil will invert. The pendulum will swing the other way where demand will outpace supply. And then the price of oil will again be too high for our liking. Price dislocations in the commodity markets are common.
And this is what creates so much risk and opportunity for investors. When the pendulum swings in the other direction, we will again be worrying. About how long will oil last and what alternative energies will be available when we run out. The question I get the most from clients is “what’s the best way to buy oil?” There are several ways to do it, but each of them come with their own set of issues. I will describe a few of the options and the plus and minus of each.
Buying Oil Futures: Buying oil futures is the most direct way for sale of the commodity. (aside from buying barrels of oil, which most people can’t do because they would need to store it somewhere). The risks of buying oil futures is that you have to be right on the price movement AND the timing of the price movement. For most investors, this is not a great way to go.
Buying Oil ETF’s: Buying an ETF that invests in oil is a great way to invest in oil, but it comes with its own set of issues. First, it’s quick and easy because of ETF’s trade on the major stock exchanges. And can be also bought through your online broker or financial advisor. The problem with these ETF’s is that these funds don’t always follow the price movement of the commodity.
The reason for this is that these funds are actually buying futures contracts. The fund has to replace the expired contract with a new contract, at the current market price. Additionally, some of these funds are using leverage to enhance returns. But it’s also possible that this goes in the wrong direction and ends up doing more harm than good. So, if you are looking for a quick trade in and out of the commodity (less than 30 days), then the ETF is a fine way to go. but I would not recommend this strategy for someone looking to hold onto the ETF for a longer period of time.
Buying Stocks of Oil Companies: Owning a company like ExxonMobil (XOM) or Chevron (CHV) is another way to take part in the price fluctuation of oil. This is a very simple way to access the market because you can buy these shares with your financial adviser. The main reason that I like this idea, over the first two ideas, is that you can buy a stock that is paying a nice dividend. While you wait for the stock to rise, because oil has rebounded, you can get paid a dividend from the company you own. ExxonMobil is paying a dividend of 3.91% and Chevron is paying a dividend of 5.18%. So, you are getting paid to wait, but dividends are never guaranteed.
Also, you can feel comfortable owning this investment for the long haul. Should it take much longer than you anticipated for the price of oil to rebound. The disadvantage of owning oil company stocks, is that they don’t move with the price of the commodity. Because the large businesses are also involved in many other things like refining. Which actually would not enjoy from higher oil prices. This is not all that bad, but it’s worth noting that you should not expect your oil stock to rise 50%, if the price of oil rises 50%.
Buying MLP’s: MLP’s or Master Limited Partnerships are another way to be a long-term investor in the oil and gas sector. Without worrying about expiring futures contracts. These companies own oil and gas pipelines that carry the commodity from one part to another. They offer attractive dividend payment and can be got through your financial advisor.
Also, there are several mutual funds that invest in MLP’s. Which would offer you more diversification than some of the others mentioned above? These company’s stock prices don’t necessary to move lock-step with the price of oil. But it’s another way to be a longer-term investor in the oil space. Without worrying about some of the other risks involved with futures.
I recommend that you take the time to learn the various options available in the eventual rise in oil prices. You might want to stick with owning consumer stocks that will likely lower oil and gas prices.
Futures trading is speculative and is not suitable for all investors.
An exchange-traded fund (ETF) is a mutual fund that tracks a specific stock or bond index. Such as the Barclays Capital 1–3 Year Treasury Index. ETFs trade on one of the major stock markets and sold throughout the day, like a stock, at current market price. And, like stock investing, ETF investing involves principal risk. The chance that you won’t get all the money back that you invested. market risk, underlying securities risk, and secondary market price
Please consider the investment objectives, risks, charges, and expenses before investing. The prospectus, which contains information about the mutual fund from your financial advisor. Be sure to read the prospectus before deciding whether to invest.
Investing in master limited partnerships (MLPs) entails more company-specific risk than other investments. And proper due diligence and suitability criteria should be also observed before investing. MLPs are also subject to general market risk and low energy demand. Risks include a slowdown in energy demand, environmental hazards, and commodity price fluctuations. In resource-based MLPs, the resource base runs out unless new assets are acquired. MLPs may become overbought. Talk to your financial advisor before making any investment decisions.
