Crude oil is essential to many worldwide industry. It is the force that powers most vehicles, powers industry, and generates energy. Because of the importance of oil to humanity, it has become a valuable commodity for many corporations and governments. Therefore, it is a popular trading instrument as an investment. Currently, you can invest in the price of oil online using CFDs without having to acquire and store it. However, someone did not really know about it, so let’s take a look in this article.
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What Exactly Is Crude Oil?
Generally, crude oil is a petroleum product that occurs spontaneously. It is made up of hydrocarbon deposits and other organic components. Importantly, it is a type of fossil fuel that is refined into usable products such as gasoline, diesel, and other petrochemicals. Moreover, it is a nonrenewable resource, which means that it cannot be replenished naturally at the pace at which we consume it. Finally, this makes it a finite resource.
Normally, crude oil is collected through drilling, where it is typically discovered alongside other resources such as natural gas and saline water. Following collection, it is refined and turned into a range of consumer products such as gasoline, kerosene, and asphalt. Although it is commonly referred to as “black gold,” it varies in thickness and color from black to yellow based on its hydrocarbon component. The first stage of refining is distillation, which is the process of heating and separating oil into distinct components.
Currently, the global economy is heavily reliant on fossil fuels such as crude oil. The desire for these resources frequently causes political upheaval due to the fact that a few countries possess the greatest reservoirs. Therefore, supply and demand have a significant impact on its prices and profitability. However, the top three oil producers in the world are the United States, Saudi Arabia, and Russia.
How to Invest in Crude Oil?
Literally, there are two main ways to invest in crude oil: directly and indirectly.
Investing in Crude Oil Directly
Generally, investing in crude oil directly can be made by purchasing futures and options contracts. They are purchased by investors to acquire direct exposure to the commodity. However, futures and options can be confusing and risky. Therefore, direct investors are often ones who are ready to accept the additional risk involved with futures, options, and speculation.
- Crude oil futures
This contract mandates a buyer to buy or sell an investment security by a stated expiration date, unless the position is closed before the expiration date. One thing to remember is that when it comes to oil futures, investors almost never expect to purchase the asset.
- Crude oil options
This contract gives the buyer the opportunity to purchase or sell the underlying asset.
Investing in Oil Indirectly
Indirect oil investments do not manage the price of oil as a commodity directly, but rather invest in equities that may be impacted by oil prices. Investors desiring indirect investing in oil are often ones who do not desire the additional risk that comes with direct investing as mentioned before. An energy sector mutual fund or ETF, for instance, is one approach to acquire wide investments in oil. It is being less sensitive to oil price movements than direct oil investments. Investors can access indirect investing in crude oil by the following ways.
- Mutual fund or a crude oil ETF
Investors can purchase shares of a mutual fund or an oil ETF that invests in the equities of oil businesses. Exploration funds and energy industry funds are two examples.
- Individual crude oil companies
Normally, crude oil companies are classified into three types: upstream companies that drill for oil, midstream companies that manage pipelines to transport it, and downstream companies that process and sell the finished products.
Risks of Investing in Crude Oil
Aside from the risks involved with trading futures in general, investing in crude oil carries the following risks:
Crude Oil Market Dynamics
Genuinely, trading crude oil in the futures market has a high learning curve. Thus, it is not always made easier by gaining exposure to the commodity through the equities market. Moreover, production-related difficulties that benefit the price of it are not always favorable for a single firm that is directly affected.
Since crude oil is very important to the worldwide economy, its price is sensitive to variations in the rate of global economic growth. Importantly, consumption of it end products such as gasoline can fluctuate as demand is discretionary. As a result, any economic downturn or recession in a large oil-consuming country, region, or much of the world will almost certainly be accompanied by a significant drop in oil prices.
Many of the areas active in the crude oil sector are experiencing conflict and political challenges. Therefore, these geopolitical concerns have an impact on supply and demand, and hence on oil prices. The instance of concern is Russia’s 2022 invasion of Ukraine. Sanctions against Russia caused the price of oil to skyrocket.
Benefits of Investing in Crude Oil
Investors who want to obtain exposure to crude oil through the stock market may benefit from dividends. This is because businesses in the energy sector are paying dividends that are expanding faster than any other sector of the U.S. stock market. Importantly, the average dividend payments have increased by more than 50% since 2018. When its prices climb, investors gain exposure to the market, but they are compensated in the meantime.
Diversification of a Portfolio
To reduce risks in your overall portfolio, it is a good idea to focus on diversity and invest in a number of different assets that do not all move in lockstep. When oil prices are increasing and stock prices are decreasing, adding exposure to crude oil or energy equities in general might help balance your portfolio.
To sum up, investors can obtain direct exposure to crude oil by acquiring futures or options. Meanwhile, investors can also gain indirect exposure by purchasing its stocks, or exchange-traded funds that invest in oil stocks or the broader energy sector. However, one thing to remember is that investing in oil has additional dangers that investors should be aware of before making a purchase.
Yes, crude oil investments can be risky due to the volatility of oil prices and the possible effect of geopolitical events on supply and demand.
Yes, there are tax implications for crude oil investments. For instance, gains from the sale of oil futures contracts are frequently regarded as short-term capital gains, which are related to higher tax rates than long-term capital gains. In addition, income from oil company stock investments are charged ordinary capital gains taxes.
Yes, a lot of internet brokerages permit the trading of oil futures contracts, options contracts, and oil company stocks. E*TRADE, TD Ameritrade, and Robinhood are well-known online brokerage firms. However, trading futures and options contracts can be more difficult and dangerous than keeping stocks.
Read more: Commodities
Source: Investopedia, Forbes