Investing in oil stocks is not for the weak hearted. With tensions between the U.S. and Iran rising, an ongoing trade war with China, and a slowdown in global economic growth, oil stocks have been very volatile in recent weeks. The turmoil has even prompted some on Wall Street to lower their oil price forecasts for the remainder of the year.
Volatility is here to stay, but that doesn’t mean investors should stay away from oil stocks. There’s a number of reasons why investing in oil makes sense as part of a diversified investment portfolio. Read on to learn the top five reasons.
Here’s Why Now Is a Great Time to Invest in Oil
1. Do the Math
The world currently produces the same amount of oil it consumes. What this means is that with every hiccup in production, such as a natural disaster or a pipeline breakage, the price of oil rises. That was on display earlier this month when tensions between the U.S. and Iran surged. Oil prices jumped as worries over production disruptions reverberated around the world.
Although the demand for oil in the United States has slowed, it is rising steadily in many other countries. And while new supplies of oil are becoming increasingly difficult to find, oil will remain a valuable commodity, even in today’s current global economic climate.
According to the U. S. Energy Information Administration, the demand for oil is likely to increase by 3.3% in China, 2.4% in India, and 1.7% in Brazil over the next few decades.
2. Global Risk Is Here to Stay
Much of the world’s oil supplies come from countries such as Iran, Iraq, Nigeria, Saudi Arabia, and Venezuela. Should civil war, infrastructure issues, or basically anything else affect the oil supply, the results could be extreme, and these oil-rich countries already carry a high risk of destabilizing events.
But the risk exists domestically as well. For example, just a few years ago, a hurricane hit off the coast of Texas. This resulted in a short-term absence of gasoline in parts of the country.
3. Downside Already Baked In
At the same time that demand for oil is declining, supply is weakening. Oil inventories have been increasing since the spring, with stockpiles expanding instead of dwindling. At the same time, production is surging, creating the perfect environment for an oversupply situation. Excess supply brings lower prices.
Meanwhile, natural gas is becoming a formidable competitor to oil. It’s cleaner to burn and cheaper to use. In the U.S., President Donald Trump recently signed two executive orders aimed at picking up the pace of natural gas pipeline projects here and abroad. That is expected to increase access to natural gas, further eroding demand for oil.
Despite all that bad news, some investors see a buying opportunity where others see more pain. They think the malaise in the oil industry will be short-lived and that many oil stocks are cheap. They think all the bad news is already baked into their share prices. That presents an opportunity for value investors to buy low and sell high.
4. Long Term Payoffs
Oil companies are in it for the long haul. When they discover oil, they basically strike gold. These oil fields can be operational for many years, giving investors a solid return on their investments, not to mention a jump in the share price. It’s a big reason why so many investors prefer the sector.
When it comes to investing, diversification is key. No one should have all their investments within one industry. Investments should be spread out across different asset classes and industries. That way if one sector is doing poorly, the others may outperform. Oil stocks give you the ability to diversify and to handle any changes in the economy. For example, with a slowing economy, oil and gas prices could increase.
Types of Oil Companies
All types of investors can put money in oil stocks. Just like with any industry, there are risky ways to do it and more conservative options. For risk-averse investors, there are integrated oil companies. These companies not only drill and produce oil, but they refine and market the oil as well. They are less risky because they are a diversified business operating in all the different areas of the oil market. They usually are large, with a lot of cash. Many pay dividends that are among the better payoffs for the industry.
More risky investors may choose to invest in refining stocks, which are companies that only focus on refining and marketing oil. They don’t explore or produce oil so their risk and return are limited to those areas. Their stocks are tied directly to the price of oil. If it’s high, they tend to suffer because demand can slow.
Independent oil companies, which don’t have a refining business, are another option for investors. They tend to be smaller than the integrated oil companies, with some also producing natural gas.
Outside of exploration and refining, there are oil services companies who provide support to the industry, whether that’s building an offshore rig or developing drill parts. They provide the products and services needed for the oil industry to find, produce, refine, and market oil. Domestically, the market is saturated, with several companies vying for business. But internationally, opportunities still abound.
How to Invest in Oil
Investing in oil is risky, there is no doubt about it — especially if you engage in oil futures trading. You need to look no further than incidents like the BP oil spill to confirm the inherent risk.
To mitigate these risks, however, you can invest in oil-focused exchange-traded funds (ETFs). These are low-cost investments that track a basket of oil stocks or index. They are passive, meaning there are no humans involved in managing the fund and can be bought and sold similar to stocks. Oil ETFs can be focused on domestic stocks, international stocks, or a mix of both. They can include different oil sectors or just one specific one. There are even ETFs that track the price of oil produced in the U.S. or abroad.
Actively managed mutual funds focused on the oil sector is another way to go. Investors tend to pay more in fees for these types of funds in the hopes of getting a better return, thanks to the money manager’s expertise.
When choosing which ETF or mutual fund to invest in, consider the fees. The lower they are, the better, because it means more money working for you. You also want to choose a fund that has several hundred million dollars or more in assets under management. This is particularly important when it comes to ETFs. Since ETFs trade like stocks, you run into a liquidity issue if it’s a smaller fund. The benchmark matters too. You want to go with an ETF whose performance matches the benchmark it’s tracking.
Investors also have the option to invest directly in the stocks of companies in the oil industry. It could be an oil producer, refiner, an integrated oil company, or an oil services firm. This route can be a little riskier since your investment is tied to the fortunes of a single company rather than a basket of stocks.
Oil may be in a state of volatility with global and economic turmoil starting to creep up. Nobody knows what will happen with the U.S. and Iran, nor can they predict how the trade war between the U.S. and China will play out and the impact on the global economy. Determining what will happen in the short-term with oil stocks may be near impossible. But it’s undeniable that worldwide demand is likely to increase, and reserves are becoming harder to find. That means the price of oil should eventually increase, creating a good environment for oil stocks. Even amid the current volatility, a long-term view of oil investing may be prudent, whether it’s as a diversification play or to get more exposure to oil.
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