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How to invest crude oil

Video How to invest crude oil

Crude oil is perhaps the most vital natural resource for the world economy. This raw material is refined to make gasoline, jet fuel, and many other products. Investors around the world closely follow price changes in the global crude oil market.

what is crude oil?

Crude oil is a type of unrefined oil. As a non-renewable fossil fuel, the total supply of crude oil is limited and cannot be replaced once it is depleted.

is found below the earth’s surface, nearly half of the supply is produced in the us. USA, Saudi Arabia and Russia. Historically, crude oil has been obtained primarily through drilling in underground or subsea reservoirs, although fracking, which injects liquid at high pressure into underground reservoirs, is a newer technique.

Once extracted, crude oil is refined and processed into a variety of products, including gasoline, diesel, jet fuel, heating oil, kerosene, asphalt, and lubricants.

These end products are then purchased by consumers, businesses and governments around the world to transport people and goods and heat homes and buildings, among a wide range of uses.

oil prices

As in any market, the supply of crude oil and the demand for its refined products dictate the price of this product.

With oil, the main driver of prices is inventory, or rather the perception of inventory, says peter mcnally, world leader in industrials, materials and energy at third bridge group limited. “As inventories go down, prices go up.”

That said, fluctuations in demand can also cause swings in oil prices. The sharp drop in demand for crude oil products amid lockdowns at the start of the covid-19 pandemic also weighed on oil prices, even causing the price of oil futures contracts to briefly turn negative for the first time. time in history.

The futures market is the main market for trading crude oil and one futures contract represents 1000 barrels. As with other commodities traded in the futures market, there are contracts for different months that dictate delivery. the price of oil refers to the price of a barrel and refers to the most active futures contract, which is the closest month for delivery.

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There are two main futures markets for crude oil: West Texas Intermediate (WTI), which is the benchmark for the North American market, and Brent, which is the benchmark for the rest of the world. while the two markets generally move directionally together, prices will often vary based on geographic factors.

how can you trade crude oil?

Futures trading is the most direct way to trade crude oil, but it is not practical for most investors.

As is the case with all derivatives (investment contracts that derive their value from an underlying asset), brokers will require futures traders to pay a “margin” up front, or a certain percentage of the value of the trade . What’s more, traders who don’t close out their position in a crude oil futures contract must be prepared for physical delivery of the barrels, and not only is it highly impractical for most people, but some brokers don’t. allow physical delivery.

“trading crude oil can be a risky business due to the volatile nature of oil prices,” says alec quaid, certified financial planner at american portfolios. “Not only do you have to understand the fundamentals, but you also have to be proficient in technical analysis.”

Fortunately, there are plenty of better ways for traders interested in oil to gain exposure to the energy market, notes Quaid. He recommends two strategies: buy individual shares of oil-related companies or invest in exchange-traded funds (ETFs) that track the oil industry.

Investing in companies that will benefit from changes in oil prices provides an easier and safer way for most people to invest in oil, and will also often pay investors in the form of dividends.

risks of investing in crude oil

Beyond the risks associated with futures trading in general, investing in crude oil presents other risks:

economic growth

Because oil is so vital to the functioning of the world economy, its price is also sensitive to changes in the pace of world economic growth. consumption of crude oil end products such as gasoline can fluctuate, as that demand is discretionary.

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As a result, if there is an economic slowdown or recession in a major oil-consuming country, region, or much of the world, it will likely be accompanied by a large drop in oil prices.

geopolitical issues

Conflicts and political problems are occurring in many of the countries most involved in the crude oil economy. these geopolitical issues affect supply and demand and, as a result, oil prices.

for example, negotiations within opec, the organization of oil exporting countries, are necessary to monitor and can rapidly change the dynamics within the oil market, quaid notes.

Dynamics within the major oil-producing countries can have a ripple effect on the world’s available oil supply. Russia’s invasion of Ukraine in 2022 is just one example because sanctions against Russia resulted in an increase in the price of oil.

“You’re investing in something that’s really sensitive to things going on geopolitically,” McNally says. At times, traders can feel almost as if they are supporting disruptions that will push the price of crude higher, she adds.

the dynamics of oil-related markets

There is a steep learning curve associated with trading crude oil in the futures market, and that is not necessarily all that simplified by choosing to gain exposure to the commodity within the stock market. Production-related issues that are good for the price of crude oil, for example, aren’t necessarily good for a specific company that is directly affected, McNally says.

benefits of investing in oil

investing in crude oil offers concrete benefits. here’s what you need to know:

portfolio diversification

To minimize risk in your broader portfolio, it’s smart to focus on diversification and invest in a variety of different assets that don’t all move at the same time. Adding exposure to crude oil, or energy stocks in general, could help balance your portfolio when oil prices are rising and stock prices are falling, or vice versa.

Because the oil industry was “shunned” by average investors for the better part of a decade, they missed out during periods of rising oil prices, McNally says.

earn dividends

Investors who choose to gain exposure to crude oil by investing in the stock market, whether through individual stocks or ETFs, can reap another benefit: dividends.

Companies in the energy sector are paying dividends that are growing faster than anywhere else in the us. uu. the stock market, according to morningstar, and the average dividend payout from these companies has increased more than 50% since 2018.

Investors gain exposure to the crude oil market when prices rise, but get paid in the meantime.

end result

During periods when oil prices are rising, many investors may be tempted to diversify into a new asset class to try and reap some of those gains. while this is certainly tempting, the reality is that trading crude oil futures probably doesn’t take into account the amount of time and effort that many average investors want to put into the market.

Here’s the truth: The oil market is dominated by professional traders who spend their entire day trying to predict short-term fluctuations in both the supply and demand for crude oil and its derivatives.

Indeed, trading crude oil is not something Quaid says he and his colleagues actively do for clients. rather, he recommends that his clients get exposure to the energy industry through ETFs.

Finally, says Mcnally, investors should be prepared for the unpredictability of this market. “This is a very cyclical industry,” she says.

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