How to invest in oil with little money
The decline in the price of crude oil this year could be an opportunity to make a profit if you know how to invest in the market
Why oil price dropped
The price of oil has hit its lowest point during the past four years. Why did it happen? One reason behind its sharp decline is the coronavirus which has caused weakening demand for oil, primarily by China as one of the biggest importers of crude oil.
Also, during a meeting with the Organisation of the Petroleum Exporting Countries (OPEC) Russia refused to cut down oil production. As a result, Saudi Arabia promised to flood the oil market and offered discounts to buyers.
You can see that during the first half of January that Brent Oil reached a price of nearly $70 and its price sharply fell down to $32 during the past two months. Now investors have plenty of crude oil investing opportunities because they may consider opening long positions.
When businesses are back to their operating capacities, the demand for oil may increase which could have positive effects on the oil price. In an optimistic scenario, if the oil-producing countries resort once again to limited production, it will affect the oil supply, which would place additional upward pressure on the oil price.
So if you decide to invest in oil by buying it at a lower price, here are the possible ways you can do it.
There are different ways to invest in the oil market even with little money.
How to invest in the oil market?
The basic way to invest in oil is to purchase stocks from well-known oil-producing companies such as Exxonmobil, British Petroleum, Chevron, etc. In general, changes in oil price have a major impact on the value of the companies. Look at the graph to see how British Petroleum (BP) stock price has changed in 2020 as a result of changes in oil price.
Invest in oil shares
The BP stock price has declined more than 50 per cent since the peak in January. Buying the stock can provide attractive profits in case the oil price and the stock price return to the pre coronavirus levels.
However, when you invest in oil shares, you should make a detailed analysis of the prospects of the company because the oil price is not the sole factor affecting the stock price.
One of the benefits of investing in oil through oil stocks is that you can decide which stocks you want to hold and how long to keep them. Moreover, it is rather simple to buy stocks through your online broker. The downside is that other factors can also have negative or positive effects on the value of your stocks.
So if want to learn how to invest in oil shares it’s an easy thing to do. First, decide which oil shares you want to purchase. Next, select an online broker and open an account and deposit funds. When everything is set up, purchase the shares of your choice.
Investing in tokenised commodities
Asset tokenisation is one of the newest forms of investing. It means creating a digital equivalent for a real asset or commodity in a form of tokens on blockchain technology. It helps to remove intermediaries and all associated costs which means tokenised commodities can be considered as an adequate investment opportunity if you want to have liquidity and flexibility.
Although it may look too complicated, buying tokenised commodities is easy. If you decide to invest in oil this way, all you need is to follow the standard steps of finding an online broker which offers this type of investment, open an account, fund it and buy the tokenised commodity of your choice.
Invest in oil-related funds
When investing in oil ETFs, you will buy shares in a fund which is traded on the stock market much the same way as company stocks. The ETFs are following the performance of oil stocks. Investing in oil through an ETF doesn't require substantial initial capital and can be a nice option for inexperienced investors or investors planning to own a diversified portfolio. Take a look at the price chart for VanEck Vectors Oil Services ETF presented below.
At the start of 2020 the ETF price was approximately £10 ($13.6) while after the outbreak of the virus it falls down to less than £4 ($5.16). In anticipation of a positive outlook for oil price this, or other, oil ETFs can be an excellent addition to your portfolio.
An advantage of investing in ETFs is the opportunity to invest in the oil industry through a diversified portfolio at a relatively low price. You can also buy ETF through your online broker, which makes it easy for investors to diversify into the oil industry.
Trade derivative instruments: options, futures, contracts for difference
Trading derivative instruments mean that the value of the traded instrument is based on the underlying asset, ie oil. Some derivative instruments, such as options, enable traders and investors to profit without the risk of actually owning the commodity. You can choose to trade the oil value through futures, options or contracts for difference.
If you decide to buy oil futures, it means that you enter a contract which enables you to purchase oil at a future date at a predefined price. Keep in mind that with oil futures, you have an obligation to fulfill your side of the agreement.
The pros of trading oil futures are that the market for this derivative instrument is highly liquid since oil futures are heavily traded. The downside is that oil futures have much higher volatility and higher risk and consequently, they are recommended for more experienced traders or investors.
Trading options is another way to gain exposure to the changes in oil prices without actually buying oil. Unlike the future, the oil options give you the right but not the obligation to purchase (call option) or sell (put option) the underlying assets at a pre-specified price. When you buy the options, you pay a premium to the seller. The good thing, though, is that you lock in the price at which you will buy or sell the oil and in case you decide not to exercise the option you stand to lose only the amount paid for premium.
Contracts for difference or CFDs can also be used when you want to open positions based on the oil. The CFDs represent an agreement in which one party should pay the difference between the price at the beginning of the contract and the price at the end of the contract. You make a profit when the price moves in the anticipated direction.
You can trade CFDs using brokers margin. With the broker leverage, you will pay only portion of the position value. For instance, imagine that you have £500 available for investing or trading and your broker offers a leverage of 1:50. If you decide to use the margin, it means that you have a buying power of £25,000. Consequently, investors with little money to invest can make higher profits thanks to the leverage provided by the broker. However, as you stand to make higher profits, you can also lose money much faster, which is why you should be cautious when deciding to utilize the power of leverage.
Derivative instruments are a practical method for making profits from changing oil prices. Nevertheless, they require that you understand how they function.
Invest in Master Limited Partnership (MLPs)
MLP or Master Limited Partnership is a form of business entity that is publicly traded similar to stocks. When becoming a limited partner, you are entitled to receive a portion of the generated profits, but you don't have control over the way the business is run. However, MPL provides specific tax benefits as a private owner which means that you will pay taxes only when profits distribution takes place. The MLP commonly deals with the storage of oil and could own a pipeline which transports the commodity between two points or an MLP can even own an oil well. Before investing in an MLP, you should perform your research to select an adequate MLP for investing.
The benefits from investing in an MLP is that you can receive substantial dividend payments and that you can easily buy MLPs through your online broker. The downside to investing in MLPs is that you will be exposed to the market risk and the general demand for oil.
So, as you can see, the steps you take are more or less the same for different types of assets. But the best way to invest in oil depends on your personal preferences and level of expertise.
FURTHER READING: Four ways to make money in commodities
FURTHER READING: Tokenised commodities: what you need to know