Becoming an oil and gas investor offers excellent financial benefits when the market works out in your favor. On the other hand, it also carries an equal amount of risk. Investing in oil isn’t for the faint of heart, but it can be a gratifying investment opportunity when done with care and diligence.
You’ll want to minimize your risk and maximize the potential for returns in your oil investments. That’s why I’m offering an overview of investing in oil and all that comes along with it. By understanding the basics of the industry and the different methods of investing, you’ll already be ahead of the curve when it comes time to make your first significant investment.
Continue reading to learn the ins and outs of the industry. I will cover the pros and cons of investing in oil, and what the next steps are if you want to go down this road.
Understanding the product and industry
First thing’s first: It’s essential to grasp a solid understanding of what petroleum is and what makes it such a commodity.
Petroleum is another name for crude oil, which is extracted from the earth with big oil rigs and then refined through several processes to create gasoline and other products.
Petroleum is a major commodity, both within the United States and around the world.
Common uses for petroleum
Petroleum products are used in more ways than you think. Many people associate oil drilling with gasoline only, but that’s simply not the case. These are just a few of the petroleum-based products out there:
- Bike tires.
- Umbrellas.
- Mops.
- Curtains.
- Toilet seats.
- Golf bags.
- Deodorant.
- Perfumes.
- Paint.
- Hair coloring.
- Refrigerant.
How supply and demand impact petroleum
There is currently no substitute available for petroleum, which gives us a high dependence on the product. Since there is no substitute, the world relies heavily on the supply of oil to create all of the above products and more.
With such high demand and a physically limited supply, oil becomes a hot commodity. Since oil is not a renewable resource, we’ll eventually get to the point where our supply greatly reduces while the demand increases. Most investors expect the future price of oil to rise because of this.
When gas prices are up, that means both oil prices and shareholders’ investments increase as well.
How do I start investing in oil?
If you’re wondering how to invest in oil and gas, there’s more than one right answer. There are about seven different ways you can get invested in the petroleum industry. From stocks and ETFs to oil futures and DPP programs, I’ll cover it all.
How to invest in oil ETFs
Stock investments, exchange-traded funds (ETF), and mutual funds are among the fastest and simplest ways to start investing in gas. For the sake of this article, I’m going to focus on ETFs here specifically.
If you want an investment route that is closely tied to the price of oil, you should consider taking the route of an ETF. ETFs offer you access to several different assets all at once while also diversifying your portfolio.
You can buy and sell ETFs just like general stocks, but they divide your investment up among different stocks. They consist of derivative contracts, company stocks, or futures that track oil prices.
To get started investing in oil ETFs:
- Research the trajectory of oil prices. Take a close look at how major ETFs respond to changing market conditions.
- Settle on your ETF investing strategy. As long as you understand how your ETF will affect your taxes, you’re then free to give your investment broker a call.
How to buy oil futures
One way that professional investors commonly make a profit in the commodities market is through oil futures. If you’re new to the world of investing or oil in general, oil futures are derivative securities that give the shareholder the right to buy crude oil at a determined price by settlement date.
As long as you exercise the future by the settlement date on the contract, you can purchase oil at the stated price. On the other hand, you can also keep an eye on the price of oil to see if it’s going to increase. In that case, you can hold onto the future while the value appreciates and then sell it later on to another investor who wants to exercise it.
To start buying oil futures:
- You’ll want to open an online futures account and wait for approval.
- Once that’s all taken care of, get ready to think quickly on your feet. Futures are volatile and will lose their value near their date of expiration, so you must make intelligent decisions quickly based on your research.
Your research should focus on the future price of oil. By forecasting the trend of the future price of oil correctly, you’ll be able to turn out a great profit. You can either short sell the future and bet against the future cost of crude oil or bet on it to rise and sell it for more.
Speaking of research, I can’t mention futures without mentioning probably the best high-end online brokerage – E*TRADE.
E*TRADE is one of the most popular brokerages today. Many view this platform as the top online broker to use. And you can invest in all types of oil stocks, mutual funds, ETFs, and most notably, futures, with the platform. E*TRADE makes it easy to buy and sell stocks while providing incredible trading tools to help out along the way. It offers some $0 trades, and takes just $1.50 commission per contract, per side for commission. There are also no platform fees.
While E*TRADE has a great online interface, the actual process of stock trading is decent. Anyone who is a serious day trader, for example, might find a better fit elsewhere.
How to invest in oil wells with DPP
Want to invest more directly? Then consider using direct participation (DPP). These are made for direct investments into the production or exploration of oil and gas.
DPPs come with two major benefits:
- Cash flow.
- Tax advantages.
They also require a lot of due diligence and come with some level of risk based on the investment.
With a DPP, you’re buying a percentage of the assets and interest of an operating oil company. This is called working interest. Essentially, you gain all the advantages of owning a portion of the business without actually setting up or getting involved with the operations.
When a DPP investment is profitable, it can become a great form of passive income with a steady flow of cash it provides.
Before you get involved with DPPs, understand that there are a few different kinds. These include:
- Exploratory Drilling Program: highest risk, involves looking for new oil in new areas.
- Developmental Drilling Program: most common, involves looking for new oil in proven areas.
- Working Interest Program: involves wells that are currently producing.
- Rework Program: least common, involves improving low-producing wells.
How to invest in oil by owning mineral rights
Investing via owning mineral rights is a different way to get involved. Investing this way means you’re buying a portion of the gas and oil rights that are still below the surface. With these rights, you can start producing oil on your piece of land. You also have the right to lease this land to another company for drilling.
Typically, this kind of investing happens through an authorized investment broker. Keep in mind that the cost of mineral rights can be extremely expensive.
One common way to handle this ownership is by leasing it to a gas company for development and then keeping a percentage of the revenue earned once it starts producing. This is called a royalty interest, and it can be a very lucrative investment opportunity for those who have the money to get started.
Is oil a good investment?
Before you decide to invest in oil, it’s a good idea to weigh out the pros and cons of the opportunity to see if it’s truly a good investment.
Pros:
- Major tax benefits, including income write-offs and passive income tax breaks.
- Diversified investment portfolio.
- A consistent flow of cash.
Cons:
- Cash flow can be directly affected by rapid changes in oil price.
- A high financial barrier of entry.
- Environmental impact and disaster liability.
Should I invest in oil?
Now that I’ve laid out the pros and cons, it’s fair to say that you should invest in oil or gas if you are comfortable with the risks involved.
Those who decide to invest should know that there is a great risk of losing money. There is also a chance you could make a lot of money. Educating yourself ahead of time is the best way to minimize your risk and increase your chances of profitability.
That being said, let’s dive into the many different ways you can invest in oil and how to get started with each.
How can I invest in oil with little money?
As mentioned above, there can be an extremely high barrier of entry for the world of oil investment. That can be frustrating for those with little money who still want to get involved in this kind of investing.
You’re probably wondering, “how much does it cost to invest in oil?” That answer varies depending on the type of investment you want to make but can range anywhere from a $2 futures contract to an oil well worth millions of dollars.
Luckily, there are still a few ways that you can get your feet wet without blowing your entire savings account.
Here are the top five ways to invest in oil without a ton of money:
- Master Limited Partnerships (MLPs): Enjoys liquidity of publicly traded companies with the tax benefits of being a partner.
- Contract for Difference (CFDs): Allows you to speculate on the price difference between opening and closing without actually buying the oil. It also doesn’t usually require a commission.
- ETFs: Offers portfolio diversification at a low price.
- Stock: Buy as much or as little as you want based on global oil prices.
- Futures: Oil futures are the most popular futures on the market, making them very liquid and accessible.
There are also some pretty awesome online brokers for investing with little money. Right now, one of my favorite low-cost online brokers is Robinhood. Founded in 2013, Robinhood continues to make a name for itself in the world of investment – both good and bad – but one of the coolest things they introduced is the ability to buy fractional shares. If you don’t have hundreds or thousands to plunk down on certain company you may be interested in, don’t worry about it! Robinhood offers you a chance to buy part of a share, reducing the cost and getting more people to invest.
Some of the biggest pros of Robinhood include their offer for signing up, the ease of opening a new account, the platform’s high performance, and best of all, zero-commission trading. You can buy oil ETFs and oil futures with Robinhood as well.
Summary
Do these options for how to invest in oil appeal to you? Maybe you are ready to become a gas and oil investor. Getting involved in oil opportunities isn’t for everyone, but when done right, it can lead to a big return on investment.
If you’re interested in stocks, ETFs, or mutual funds, you should start learning about stock trends and explore where you’d like to open up a stock account. If you’d rather get more directly involved, start by contacting a reputable oil and gas broker or attorney to learn more.
With proper due diligence and continued financial education, you can reap the many benefits of investing in oil.
