How to invest in oil

Oil is a volatile commodity, the value of which is driven by supply, political and environmental factors — and the demands of energy-driven nations. There’s no telling which direction the oil supply of other oil-producing countries will go, and the Middle East is no stranger to conflicts that disrupt the oil industry.

Each of the four investment options available for this commodity comes with risk, given you’re making a bet as to how much oil will sell for.

Client disclaimer: US Brokerage services through eToro USA Securities Inc, member of FINRA, SIPC. Crypto assets through eToro USA LLC.

1. Invest in oil ETFs.

Worth considering are exchange-traded funds (ETFs), which provide access to a variety of assets without putting all of your money into individual stocks. Rather than buying a stock, you’re buying an oil ETF, which typically tracks several oil stocks’ performance.

Purchasing commodity-based oil ETFs is a direct way to invest in oil. ETFs allow investors to minimize risk while taking advantage of the performance and general popularity of a particular sector. And oil ETF investors can avoid the risk of exposure to single stocks that fluctuate based on oil prices.

Oil ETFs can be a good choice for those who are new to investing or looking to diversify their portfolio, and you have many oil-based ETFs to choose from, covering many companies in the industry. Here are some of the more popular options.

  • US Oil Fund (USO): An ETF that directly tracks the price of oil through futures contracts on the benchmark West Texas Intermediate (WTI) crude oil.
  • ProShares Ultra Bloomberg Crude Oil (UCO): A leveraged ETF that tracks the price of WTI crude oil and aims to double the daily price movements.
  • SPDR S&P Oil & Gas Exploration & Production ETF (XOP): An ETF that tracks an index of the stocks of oil producers and explorers.
  • VanEck Vectors Oil Services ETF (OIH): An ETF that tracks an index of the stocks of companies that provide support services to oil producers and explorers.

Leveraged ETFs

If you’re considering a leveraged oil ETF like UCO, be careful. Leveraged ETFs are not designed to be bought and held for long periods of time — rather, they’re designed for short-term trades.

To achieve double or triple the returns of the futures or stocks they’re based on, these ETFs invest in options and derivatives that require a daily rebalancing of the ETF’s assets and target exposure. Therefore, the asset base is constantly changing, and extreme volatility can erode the basis of your investment.

2. Invest in MLPs.

Existing primarily in the gas and oil industry, a master limited partnership (MLP) is a tax-advantaged corporate structure that combines the tax benefits of a partnership with the liquidity of a public company. Like a partnership, profits are taxed only when investors receive distributions.

MLPs typically own the pipelines that carry the commodity from one place to another, and they are known for paying high dividends, which makes them a popular option for investors who are seeking a long-term stream of income. MLPs are still volatile, though, and risks could come from a slowdown in energy demand, environmental hazards, commodity price fluctuations and tax law reform.

You’ll find MLPs listed in a brokerage account just like stocks and ETFs. Here are a few of the biggest ones:

3. Invest in oil companies.

A simple way to invest in oil is by buying stocks of oil companies like:

As the cost of oil changes, so do the values of these companies — although there’s no guarantee, given the factors they depend on.

In addition to the major oil companies, there are also companies that specialize in specific aspects of the industry. Here are a few examples:

Understanding the energy cycle, the industry’s landscape and the impact of price fluctuations can help you determine valuable oil-related assets.

4. Invest in oil futures.

Futures are the most direct way to purchase this commodity without literally purchasing barrels of oil, but they’re a more advanced and complex investment option the majority of brokerage accounts don’t offer. You buy a futures contract through a commodities broker to purchase oil at a future date at a specified price. Purchases must take place before the contract expires.

Futures are extremely volatile and riskier than other investment options. You must be correct on the timing and price movement to see a profit. If you’re interested in futures, you’ll first have to choose a brokerage account that supports futures trading.

Compare these platforms to invest in oil

How much is oil worth today?

The graph below tracks the price per barrel of oil in US dollars over time.

What are the risks of investing in oil?

While long-term investments in oil companies can be highly profitable, understand the risk factors before making investments in the sector:

  • Price volatility. Wide price fluctuations can occur daily due to unpredictable influences like supply and demand.
  • Dividend cuts. If a company is unable to earn enough revenue to fund payments to investors, it may cut dividends.
  • Oil spill risk. Accidents can cause a company’s share price to drop significantly. In 2010, BP saw a decline of more than 55% to its stock in the wake of the Deepwater Horizon oil spill.

Bottom line

Get involved in oil through four main methods, each with its own set of risks. Before you buy, explore investment options for other tangible goods through multiple trading platforms.

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