How to invest in oil with little money
Crude’s price fluctuations could make you a profit if you know how to invest in the market
Why oil price dropped
In April 2020, the price of oil hit its lowest point for four years. Why? The major reason behind its sharp decline was the coronavirus pandemic which weakened demand for oil, particularly in China which is one of the world’s biggest importers of crude oil.
The other factor was Russia’s refusal to cut oil production during a meeting of the Organisation of the Petroleum Exporting Countries (OPEC) in March 2020. As a result, Saudi Arabia decided to flood the oil market and offer discounts to buyers.
Brent Crude had been trading at around $51 per barrel at the start of March 2020, but six weeks later, it had dropped below $16. It climbed back above $40 in summer 2020, and returned to pre-pandemic levels in March 2021, a year after the first coronavirus wave forced countries into lockdown.
Now, at the time of writing, it’s trading above $84. As businesses near or reach their operating capacities, the demand for oil has increased and so has the price.
It was relatively simple to invest in the oil market even with little money in 2020. Now one has to be wiser. Another chance to buy low and sell high could be on the way, however, according to the US Energy Information Administration (EIA) October forecast.
“In 2022, we expect that growth in production from OPEC+, US tight oil, and other non-OPEC countries will outpace slowing growth in global oil consumption and contribute to Brent prices declining from current levels to an annual average of $72 per barrel,” the EIA report stated.
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, and so on. In general, changes in oil price have a major impact on the value of these companies. Look at the graph to see how the British Petroleum (BP) stock price has changed in 2020 and 2021 as a result of changes in oil price.
Invest in oil shares
The BP stock price is currently more than 27% off its early 2020 peak. Buying the stock can provide attractive profits in case the oil price and the stock price return to their pre-Covid levels.
When you invest in shares in oil companies, however, you should make a detailed analysis of the prospects of the business because the oil price is not the sole factor affecting the stock's value.
One of the benefits of investing in oil through oil stocks via a company is that you can decide which stocks you want to hold and how long to keep them. It’s also relatively simple to buy these 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 via a company it’s an easy thing to do. First, decide which oil shares you want to purchase. Next, select an online broker, 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 of a real asset or commodity in the 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 complicated, buying tokenised commodities is easy. If you decide to invest in oil this way, all you need to do is to follow the standard steps of finding an online broker who offers this type of investment, then open an account, add funds and buy the tokenised commodity of your choice.
Invest in oil-related funds
When investing in oil ETFs, you buy shares in a fund which is traded on the stock market in much the same way as company stocks. These ETFs then follow the performance of oil stocks. Investing in oil through an ETF doesn't require a substantial initial injection of 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.
What is your sentiment on OIH?
At the start of 2020 the US oil fund ETF price was approximately $100. After Covid-19 hit, it dropped to $35. If you anticipate a positive outlook for the oil price then this – or a similar – oil ETF could 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 ETFs 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 means that the value of the traded instrument is based on the underlying asset – in this case, oil. Some derivative instruments, such as options, enable traders and investors to profit without the risk involved in 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 that 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 are consequently 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 futures, oil options give you the right to purchase (call option) or sell (put option) the underlying assets at a pre-specified price without obliging you to do so. When you buy these options, you pay a premium to the seller. The advantage of this approach is that not only do you lock in the price at which you’ll buy or sell the oil, you only stand to lose the premium you paid if you subsequently decide not to exercise the option.
Contracts for difference or CFDs can also be used when you want to open positions based on oil. 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 your chosen direction.
You can trade CFDs using a broker’s margin. With the broker leverage, you’ll only pay a 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 this 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. Just as you stand to make higher profits, however, you can also lose money much faster, which is why you should be cautious when deciding to utilise the power of leverage.
Derivative instruments are a practical method for making profits from changing oil prices. Nevertheless, it’s important that you understand how they function before using them.
Invest in Master Limited Partnership (MLPs)
MLP, or Master Limited Partnership, is a form of business entity that is publicly traded in a similar way 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. MPLs provide specific tax benefits as a private owner, however, which means that you will pay taxes only when profit distribution takes place. MLPs commonly deal with the storage of oil – some may own a pipeline that transports the commodity between two points, but others may 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, level of expertise and attitude to risk. As always, you should never invest more than you can afford.