The Risks and Rewards Of Investing In Oil

Oil is one of the most sought after commodities on the planet, probably rivaled only by gold. In fact, most analysts regard investing in oil as much safer than investing in gold, partly because gold is so easy to counterfeit. However, many people are very confused about the most advantageous way to invest in oil, as the fluctuating prices make it sound very risky.

Probably the least risky type of investment in the energy sector is via mutual funds. It is possible to select funds which concentrate on stocks from this sector, and these are suitable for long term investors who can stay in long enough to take full advantage of the rise and fall cycle of energy prices. However, mutual funds provide virtually no tax advantages.

One of the most popular ways to invest in oil is through oil stocks – that is, buying shares directly in some of the big companies in the energy industry. This is more risky, though potentially more profitable, than going with mutual funds, because of the extreme volatility of energy stocks. It is important to spread investments, rather than concentrating on a single company, and also to understand how to choose the right kind of stock.

There are two main types of energy company: E&P (exploration and production) companies, and drilling and service companies. The E&P companies carry out two kinds of activity – exploratory wells, and development wells. Exploratory wells are those drilled in the hope of finding new supplies, and represent a high risk, but potentially a very high reward if a new reservoir is found. It is recommended that those considering investment in E&P companies should develop their understanding of the process of oil production, and its basic terminology, in order to be able to compare different stocks.

E&P companies usually hire drilling companies, rather than owning their own equipment and employing staff themselves. The drilling companies also deal with the processes of generating and monitoring production, and the other activities connected with getting oil to the market. The revenue from drilling and service companies is linked less with the direct profits of E&P, and more with what is called the rig count – that is, the level of activity in the industry as a whole. Investors therefore need to develop a feel for the general landscape of the industry. Often a company’s past drilling success record can be an indicator of its future success.

The method of investing in oil that is most often recommended is purchasing an oil ETF (Exchange Traded Fund). ETFs are funds which track the price of oil, and consist of a group of oil assets which could include futures, stocks and derivative contracts. Buying an ETF saves you from having to choose specific companies in which to invest. You only pay the fee for a single transaction, and only a single commission, rather than commissions for each individual stock. In addition, one of the biggest advantages is that, unlike mutual funds, ETFs do not incur capital gains tax until the fund is sold. Before deciding on this type of investment, it is important to do thorough research, and specifically to track the way oil ETFs react to fluctuations in energy prices.

For those who decide to invest in oil, there is a wide variety of options, which can suit different levels of tolerance to risk. In all types of investment, higher risk means higher reward, but in this sector particularly, a certain degree of knowledge and research is required in order to make the best decisions. If you can find the option that suits you, you will find investing in oil exciting, as well as potentially very profitable.