Quick Start Guide for Oil Market Investment

The oil market can be very chaotic for both professional investors and individual investors, and sometimes huge price fluctuations occur every day. This article provides a broad overview of the forces driving the oil market and how to hold a financial interest in oil in your investment portfolio.

Key points

  • As a commodity, the price of oil on the market depends on the relationship between supply and demand, but its supply is controlled to some extent by the OPEC cartel.
  • Trade of different grades of oil in different markets, such as West Texas Intermediate (WTI) or Brent crude. It may also be “light” or “sweet” in nature.
  • Oil is sometimes seen as a tool to diversify investment portfolios and hedge against inflation.
  • For most investors, buying and selling physical oil is not an option, but you can find a liquid market that tracks oil prices through futures, options, ETFs, or oil company stocks.

Require

The U.S. Energy Information Administration (EIA) estimates that by 2021, the current world oil demand is 98 million barrels per day.When oil prices rise, demand in the United States will decrease, but as these countries industrialize, demand in emerging market economies is expected to increase.

Some emerging market economies provide consumers with fuel subsidies. However, subsidies are not always good for a country’s economy, because although they tend to stimulate demand in the country, they can also cause the country’s oil producers to sell at a loss. Therefore, removing subsidies allows a country to increase oil production, thereby increasing supply and lowering prices. In addition, cutting subsidies can reduce the shortage of refined products, because higher oil prices encourage refineries to produce products such as diesel and gasoline.

supply

On the supply side, about 94.25 million barrels of oil will be produced per day in 2020.The new reserves discovered in 2017 are the lowest level since the 1940s.Since 2014, the number of discovered reserves has been declining every year as oil exploration budgets have been cut along with the decline in oil prices.

In OPEC, most countries do not have the capacity to produce more oil. Saudi Arabia is an exception. As of 2020, its remaining oil production capacity is estimated at 1.5 to 2 million barrels per day.The United States, Russia and Saudi Arabia are the world’s leading oil producers.

In the spring of 2020, oil prices plummeted amid the economic slowdown. OPEC and its allies agreed to a historic production cut to stabilize prices, but they fell to a 20-year low.

Quality and location

One of the main problems facing the oil market is the lack of high-quality low-sulfur crude oil, which is the type of oil that many refineries need to meet stringent environmental requirements, especially in the United States. This is why despite the increasing oil production of the United States, it still has to import oil.

Each country has different refining capabilities. For example, the United States produces large quantities of light crude oil that can be exported. At the same time, it imports other types of oil to maximize production based on refining capacity.

There are also differences in the places where oil is produced and sold. For example, the main difference between Brent crude oil and West Texas Intermediate crude oil is that Brent crude oil comes from oil fields in the North Sea between the Shetland Islands and Norway, while West Texas Intermediate crude oil comes from American oil fields. , Mainly located in Texas, Louisiana and North Dakota. Brent crude oil and West Texas Intermediate crude oil are homogeneous, light and sweet, making them ideal for refined gasoline.

Speculation

In addition to supply and demand factors, another force driving oil prices is investors and speculators bidding for oil futures contracts. Many major institutional investors now participating in the oil market, such as pension funds and endowment funds, hold commodity-linked investments as part of long-term asset allocation strategies. Others, including Wall Street speculators, trade oil futures in a short period of time to make quick profits. Some observers attribute the short-term sharp fluctuations in oil prices to these speculators, while others believe their impact is minimal.

Oil market investment options

Regardless of the root cause of oil price changes, investors who want to invest in the oil market and take advantage of energy price fluctuations have many options. Most oil trading takes place in the derivatives market, using futures and options contracts. These may be beyond the reach of many individual investors, but there are several other ways to add oil to your investment portfolio. An easy way for ordinary people to invest in oil is through oil drilling and service company stocks. In addition, investors can indirectly access oil by purchasing ETFs in the energy sector. There are several industry mutual funds that mainly invest in energy-related stocks, such as the iShares Global Energy Industry Index Fund (IXC), and energy industry mutual funds, such as T. Rowe Price New Era Fund (PRNEX). These energy-specific ETFs and mutual funds invest only in the stocks of oil and oil service companies, which are relatively risky.

Investors can gain more direct exposure to oil prices through exchange-traded funds (ETF) or exchange-traded notes (ETN). These funds usually invest in oil futures contracts rather than energy stocks. Since oil prices are largely unrelated to stock market returns or dollar movements, these products follow oil prices more closely than energy stocks and can be used as hedging and portfolio diversification tools.

Investors have a variety of ETF and ETN options to choose from, such as a single-commodity ETF (for example, oil only) or a multi-commodity ETF that covers multiple energy commodities (oil, natural gas, gasoline, and heating). Investors have many options.

Bottom line

Investing in the oil market means investors have multiple choices. From indirect exposure through energy-related stocks to more direct investment in commodity-related ETFs, the energy industry can meet almost everyone’s needs. As with all investments, investors should conduct their own research or consult investment professionals.

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