Investing in Oil and Gas
Commodities are a great source of investment and many investors have traded in potatoes, soya, gold, silver etc. over the decades. Some of the major commodity exchanges are the New York Mercantile Exchange (NYMEX) and the Chicago Mercantile Exchange (CME) with the Commodities Futures Trading Commission (CFTC) providing regulatory oversight in this regard. Energy sector investments are also very large as investors look to invest in oil markets and capitalize on energy price fluctuations. Different investment vehicles in the oil and gas sector are available to cater to investors’ preferences and risk appetite. So, what are some of these investment vehicles? Let’s find out more in this blog.
Exchange Traded Funds
Greater exposure to the price of oil can be gained through an energy-sector exchange-traded fund (ETF) or exchange-traded note (ETN), which typically invests in oil futures contracts rather than energy stocks. Several sector mutual funds that invest mainly in energy-related stocks are available like the iShares Global Energy Sector Index Fund (IXC), and energy-sector mutual funds, like the T. Rowe Price New Era Fund (PRNEX). These energy-specific ETFs and mutual funds invest solely in oil stocks and oil services companies and come with lower risk. Because oil prices are largely uncorrelated to stock market returns or the direction of the U.S. dollar, these products follow the price of oil more closely than energy stocks and can serve as a hedge and a portfolio diversifier.
Options and Futures
One can also invest in crude oil options, which are contracts that give the option holder the right (but not the obligation) to buy or sell securities at a fixed price. These securities are derivatives which have oil or other oil-related product as the underlying asset whose movements determine the possibility of option exercise. Investing in crude oil options limits the potential for loss and may help protect against adverse commodity price movements.
Crude oil futures are traded on the NYMEX and the CME and are the most actively traded futures contract for a physical commodity. They are popular as they possess strong liquidity and price transparency. Crude oil futures provide individual investors an investment avenue in a vital commodity market. However, crude oil futures are leveraged which increases their risk as compared to other investments. Crude oil investment also impacts the metal fabrication industry due to existing interdependencies.
Risks of Investing
There are many risks which need to be taken into consideration in the context of investment in the crude oil markets. Some of these risks are highlighted as follows: –
Risk of Loss – Futures contracts are leveraged or “margined,” which means one may be liable for losses above the initial deposit. Risk tolerance, investment experience and securities knowledge should be gauged prior to investment in crude oil futures.
Volatile Market – The crude oil market is subject to periods of high volatility, and over time, oil prices have fluctuated significantly. For example, during the 2020 recession, the price of West Texas Intermediate (WTI) tumbled. At the start of February 2020, the price was $50.06 per barrel. On April 20, 2020, it closed at -$36.98 per barrel.
False Information – Some brokers and firms claim that crude oil investments soar during and after natural disasters. This claim has no real backing, and natural disasters don’t necessarily increase the chances of profiting in commodity futures or options trades based on crude oil. Manipulation of the oil market is also a very real scenario.
Final Thoughts
Investments in oil and gas are exciting, especially since it is a globally connected market which impacts nearly all economies globally. However, the ever-changing geopolitical and economic factors mean that the oil market can also lead to large losses in case of incorrect or short-sighted investments. Risks need to be understood and taken into account while investing in the energy industry and measures should be taken to ensure losses are limited. There is a difference between hedging and speculation – in the case of oil markets, speculation is a definite no-no!