Oil company stocks: how to invest in them?
Some of the richest people in the world, such as John Rockefeller, Jean-Paul Getty, the Koch brothers and many others, made their huge fortune by investing in oil or by creating their own oil companies. If you too want to learn how to take advantage of oil price dynamics and invest in oil stocks for profit, you've come to the right place.
Oil company stocks: what is an oil company?
- The ever-growing population of the Earth and the developing world economy require more and more energy. That is why oil and oil companies play an important role. First, let's give a brief definition of an oil company:
- An oil company is a company operating in the petroleum industry and engaged in the exploration, production, transportation, processing and sale of petroleum products or providing services to the petroleum industry.
Some interesting facts about the oil industry:
- The earliest known oil wells were drilled in China in 347 or even earlier.
- The first oil company in the world was founded in Scotland and was called EW Binney & Co.
- The first oil refinery in the United States was founded in Pittsburgh, Pennsylvania in 1853.
- In 1870, John Rockefeller founded the famous Standard Oil Company.
- In 1911, Standard Oil became a virtual monopolist and was divided into 34 smaller companies, which include such giants of modern industry as ExxonMobil, Chevron, Marathon Petroleum, etc.
Shares of oil companies: types of companies
As you already know, oil companies can operate in completely different segments of the oil industry, and it is important for an investor to know exactly which segment of the oil industry he is investing in. It is also important to know the company's role in the oil industry, as this can have a significant impact on profits.
The main types of oil companies are:
Oil exploration and production companies. They are most vulnerable to fluctuations in oil prices. One example of such a company is ConocoPhillips (#COPNY).
Companies engaged in the transportation of oil through pipelines or ships, as well as its storage in terminals. They often operate on long-term, fixed-rate contracts and are somewhat immune to the effects of oil price fluctuations. One such company is Enterprise Products Partners (#EPD).
Companies engaged in the processing of oil into other petroleum products or the sale of refined products to the final consumer. Some do both. Companies that own refineries and gas stations are a typical example of such companies. For example, Phillips 66 (#PSX).
integrated companies. Oil companies of this type operate in more than one of the aforementioned segments, and often in all three. They are sometimes referred to as "integrated giants". Here are the names of some of the giants in the oil industry: ExxonMobil (#XOM), Chevron (#CVX) and Royal Dutch Shell (#RDSA).
oil service companies. This type of oil company is responsible for the provision of equipment, operational maintenance and logistics organization of the first type of companies. An example is Schlumberger (#SLB).
Here is an example of how different types of oil companies earn:
An oil producer makes money by selling oil. Therefore, he makes a good profit when the price of "black gold" rises and far exceeds the average production costs. Such companies sometimes struggle when oil prices plummet.
At the same time, refiners usually buy oil from producers, which means that they have the opportunity to earn more at lower oil prices.
Oil transportation companies usually generate stable cash flow. They can make money when oil prices rise or fall because they simply collect a fee based on the volume of oil transported.
In most cases, extractive companies have the greatest potential for earning from rising oil prices. At the same time, such activities are associated with rather high risks.
To manage the risks associated with investing in oil companies, investors prefer to invest in shares of companies from different segments of the oil industry or choose integrated companies.
Oil Company Stocks: Why Invest in Them?
The oil industry has been hit hard by the crisis caused by the Covid-19 pandemic, although some problems started even earlier (for example, the price war between Saudi Arabia and Russia). However, in recent months there has been a steady recovery in the sector.
In June 2021, OPEC released a report through which we learned about the organization's expectations for 2022. OPEC predicts a significant increase in oil consumption and a possible increase in its production by 1.4 million barrels per day from each member of the organization.
If this is not enough for In order to start investing in oil companies, here are some other reasons that will probably convince you to do so:
- Virtually zero interest rates on bank deposits
- Inflation well above deposit interest rates (inflation protection)
- Current programs to stimulate the global economy, increasing the money supply and inflationary pressures
- Investing in global economic growth (oil is one of the engines of global economic growth)
- Opportunities for capital growth and achievement of financial goals
- Opportunities to create a stream of passive income through the receipt of dividends
- Possibility to diversify portfolio of assets
- Very high liquidity of assets (you can buy and sell shares of oil companies in seconds)
- Thanks to high liquidity, you can benefit from low investment costs (spreads and commissions).
- Small initial investment
Oil Company Stocks: How Much Should You Invest?
The answer to this question depends on three factors:
- Personal financial opportunities
- Personal financial goals
- Personal degree of willingness to accept risk
- Personal financial capabilities are very individual, so it is impossible to name the exact amount with which to start investing.
Try to determine the time for which you can invest funds without having to use them. This will depend on whether you are looking for short term or long term investments. Setting aside funds to invest (for example, a certain amount each month) can turn seemingly small returns into significant ones, especially when it comes to long investment periods.
At the same time, you should define your financial goals. What will you need funds for in the future? You might want to buy a house or a car, pay for your child's education, plan a vacation abroad, start or continue to develop a business or start a new venture, or simply have enough money to live comfortably after retirement.
The answers to these questions will help you set your financial goals.
The next aspect that you need to consider is the degree of your willingness to take risks. It depends on factors such as current income, savings, expenses, financial obligations and financial security for life and health, and finally your own temperament.
Both longer investment periods and a higher rate of return and risk of investment can bring very similar results from investing funds. From this we can conclude that different ways of investing are suitable for different purposes.
Oil stocks: risks when investing
Like any investment, investing in oil companies carries certain risks. If you are considering adding oil stocks such as ExxonMobil or Royal Dutch Shell to your investment portfolio, the following risks are worth considering:
Stock price volatility: Oil prices and stock prices of oil companies are known for their high volatility. This is suitable for high risk investors seeking higher returns, but not suitable for more conservative investors.
Political Risks: Changes in regulations in oil exploration and production, attempts to nationalize businesses, and oil production in politically unstable regions are factors to consider when buying shares in oil companies.
Geological risks: Production of oil fields in some locations can be hampered by terrain, which can increase costs and reduce the profitability of fossil fuel extraction.
Renewable energy: Some countries around the world are seeking to reduce the impact of oil on the energy sector of the economy through the use of various types of renewable energy.
Oil spills and oil accidents: Incidents like these can lead to a decrease in public confidence in oil companies, which in turn can lead to a drop in share prices.
Of course, with the right investment strategy and risk management, you can manage these risks.
How to buy shares of oil companies?
In order to start investing in oil stocks, you need the right tools and good investment conditions. Let's take a look at what trading and investment tools you can use?
The first step is to open a live account with a regulated broker.
Then you need to download a trading platform that will give you access to oil stocks.
Once you have found a broker and acquired a trading and investment platform, you should consider various financial instruments that will give you access to the oil industry.
Options for investing in oil stocks include:
- Shares of oil companies
- Contracts for Difference (CFDs) on Oil Company Shares
- Exchange-traded funds (ETF) for shares of oil companies
- Each of these investment options has its own advantages and disadvantages, and it is up to each investor to choose (taking into account their personal financial capabilities, goals and risk appetite) which instruments are right for them.
Let's take a closer look at all three of the above investment opportunities.
Shares of oil companies
A share is a security that provides its owner with a share in the capital of a company. A share is a unit owned by a company.
For example, if a company issued 100 shares and you bought 10 shares of that company, then you own 10% of the shares. Owning shares provides you with (but not always):
- Right to receive dividends
- Voting rights at the shareholders' meeting
- The right to part of the property remaining after liquidation
- Most companies issue and sell shares to raise additional capital to finance their activities.
Benefits of investing and trading stocks:
- Real ownership of a part of the business and all property rights associated with it
- Less risk due to no leverage
- No swap for transferring an open position to the next day
- More stable regulation
At the same time, the disadvantages of investing and trading stocks compared to stock CFD trading are:
- Inability to open short positions
- Inability to use leverage
- The presence of commissions when buying and selling
- Inability to trade on different markets
Oil Company Shares: Share CFDs
CFD (Contract for Difference) is a contract for difference, which is concluded between a trader and a broker to transfer the difference between the current value of an asset and its value at the end of the contract. This contract is active until closed by the trader and is executed without delivery of the underlying asset.
In fact, CFDs give investors almost all the benefits of investing in financial instruments, but without actually owning them.
First of all, we note the advantages of trading contracts for difference:
- Sell orders. One of the main advantages of CFD trading is the ability to go short. Thus, you can potentially benefit from both rising and falling prices.
- Using leverage. Thanks to the leverage, you can open positions on CFDs, the volume of which significantly exceeds the funds in your trading account.
- Ability to make transactions throughout the day. By trading CFDs, you can take advantage of short-term price movements in the stock, index or commodity markets.
- Easy access to global markets. You get access to many financial instruments such as stocks, bonds, currencies, commodities, cryptocurrencies, etc.
- When trading CFDs with Admirals, there are often no commissions for opening and closing positions.
- Multiple trading styles available (at least on some brokers like Admirals).
Like any investment and financial instrument, CFDs have their drawbacks:
- There is no ownership of the underlying asset, and therefore you have no property rights in the event of a bankruptcy of the company.
- CFD is a less regulated product.
The leverage effect is a double-edged sword: in addition to increasing potential profits, leverage also increases potential losses.
- Swap accrual for transferring open positions to the next day.
Oil stocks: exchange-traded funds (ETFs)
ETF (English Exchange traded fund) or exchange-traded fund. An ETF is a basket of securities that you can buy and sell on stock exchanges through a financial intermediary (broker).
These funds can invest in various asset classes (stocks, bonds, indices, commodities, currencies, etc.). There are many different exchange-traded funds that invest in stocks in the oil industry.
Benefits of investing in Oil ETFs:
- Cost reduction, because you can buy a basket of shares at once instead of buying them one by one
- Direct portfolio diversification
- Tax efficiency (for example, actively managed mutual funds often buy and sell assets, resulting in taxable capital gains, which cannot be said for ETFs)
- ❕In some cases, ETF liquidity may be lower than stock liquidity
- ❕There may be some discrepancies with the movement of the underlying asset
It is important to remember that there is no right or wrong tool for investing in oil stocks. You just need to choose the most appropriate tool for your trading and investment style.
Oil stocks: how to choose the best stocks?
Investing in and trading oil stocks can be tricky.
Before investing in or trading in any oil-related instrument, study the underlying asset. Regulatory and policy changes are key. Therefore, it is worth keeping a close eye on the political situation and any changes in policy in order to use this information to gain benefits and prevent serious losses.
Oil stock prices are highly volatile and depend on a number of factors. Despite all the efforts to develop and use renewable energy, the demand for oil and natural gas remains high. While there are certainly risks associated with investing in oil companies, the potential for profit is quite high.