Making Your Dollars Work for You a Guide to Investing in Petroleum Markets

7/28/2019 Making Your Dollars Work for You a Guide to Investing in Petroleum Markets

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INVESTING: MAKING YOUR DOLLARS WORK FOR YOUA GUIDE TO INVESTING IN PETROLEUM MARKETS

The price of a barrel of oil is mentioned each day on every news

program. It has almost become an economic indicator of sorts.

We've all seen that several of the billionaires in the world reached

that milestone through oil businesses or investments. Obviously,

there is a lot of upside to getting involved.

If petroleum markets are confusing to you, you’re not alone: bothindividual investors and most professionals fi nd them perplexing.

Why does the price fluctuate so much on a daily basis? We're going

to attempt to understand the market forces at work and how to

invest in petroleum related entities.

Price Influencers

1. Demand. Just like you learned in high school economics class,demand has a significant impact on price. The daily demand for

oil is around 85-90 million barrels per day. While the demand in

the United States does drop to some extent when prices rise, in

many emerging markets, the demand doesn’t drop noticeably.

‣ The demand in these emerging markets is only expected to

increase over time. In fact, in many of these countries, there

are subsidies for consumers. Approximately 25% of the

demand for oil is from countries with subsidies in place.

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‣ Unfortunately, these subsidies can actually hurt that

country's local oil production. This results in less supply,

which only serves to increase demand and the price of abarrel of oil. Removing the subsidies can increase local

production by allowing smaller, local refiners get a more

competitive price.

2. Supply. The supply tends to match the demand side quite

closely. Most of the largest oil producers don’t have the ability

to pump significantly more oil. Saudi Arabia is usually the only

exception.

‣ Nigeria has a lot of capacity, but the political instability

makes the supply of oil from here unstable. Even the

off shore rigs are attacked from time to time. The lack of

stability on the supply side can cause price fl uctuations.

3. Quality. As environmental regulations increase, the quality of

crude oil is becoming more important. This higher quality oil is

frequently referred to as "sweet" crude. Much of this oil comes

from Nigeria and the surrounding region. Recently, the US has

imported more oil from Nigeria and Angola than from Saudi

Arabia.

‣ This issue of crude quality is likely to have even more

impact in the future.

4. Speculation. Speculation has possibly become a major factor in

the price of oil. Large institutional investors have become very

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active in investing in oil futures contracts. While many experts

believe that these activities have only a minimal eff ect on the

price of oil, others believe they have a significant eff ect.

‣ It’s possible that speculation is largely responsible for the

large increase in the price of oil, and consequently, gasoline

over the last 10 years.

Investing Options

Regardless of the reasons for the price fluctuations, there are

several options for those who want to profit from the oil industry.

Let's take a look at your choices.

1. Oil Stocks. Oil exploration, drilling and service, and refining

companies off er a simple way for the typical investor to become

involved in the industry. These companies off er exposure to the

industry other than the obvious (Exxon, Mobil, and more):

‣ Exploration and Production Companies (E&P). These firms

find petroleum reservoirs, drill wells, get the raw materials

out of the ground, and then sell them to refining companies.

There are hundreds of these companies on the US stock

exchange. Understanding oil production basics is important

if you're going to invest here.

‣ Drilling and Service. The E&P companies typically do not

have their own drilling equipment or the staff to run it.

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- Drilling companies are hired to drill the well and get

everything in place so the material can be removed from

the ground. These companies are paid for their time, not

for the amount of production that results.

- Service companies are hired to maintain and service the

wells. The revenue of these companies is largely tied to

the number of active wells they’re servicing at any time.

‣ Refining Companies. These companies take the raw crude

oil and refine it into diesel fuel, gasoline, heating oil,

kerosene, and other products. While the previous types of

companies are considered to be the upstream part of the

industry, refining companies are on the downstream side.

2. Sector Mutual Funds. These mutual funds specialize in all

things energy related. You can find a fund that invests in the

types of companies that interest you in accordance with your

risk tolerance.

3. Exchange-Traded Funds. If you're interested in more exposure

to the price fluctuations of oil, these are ways to invest in oil

futures without having a futures account. Oil stocks and

related mutual funds are not heavily correlated with daily price

fluctuations of oil.

‣ You have many options here, from investments in oil only to

investments that cover several products (oil, heating oil,

gasoline, and more).

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‣ For example, if you own one share of U.S. Oil Fund ETF

(AMEX:USO), you would own approximately the equivalent of

one barrel of oil. If the price of oil rises 10%, you would make10% if you sold that share. There are brokerage fees and

management fees to deal with as well.

‣ While you don't have to do anything other than buy and sell

the shares, these investments are quite complex for the

management teams running these funds. It would be wise to

learn as much as you can.

‣ Understand that the primary way these funds invest is

through futures contracts. This essentially means that these

funds are betting on what the price of oil will be at some

future date in the future.

Conclusion

There are a variety of ways to invest in the petroleum market.

Stocks and mutual funds provide exposure that is relatively

sheltered from the daily fluctuations in the price of petroleum

products. Exchange-traded funds off er the short-term investor a

lot of exposure to those same price fluctuations.

Those with the nerve to go it alone can invest in futures on their

own. Always remember that any investment vehicle that o ff ers

the opportunity to make a large amount of money in a short

period of time also typically o ff ers the opportunity to lose money

quickly. Educate yourself before taking the plunge.

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Making Your Dollars Work for You a Guide to Investing in Petroleum Markets

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