How to Invest in Oil: A Comprehensive Guide

Oil is hovering around $30 a barrel, down from over $140 in 2008. Some analysts are predicting oil dropping as low as $15 – $20 a barrel, but the larger consensus is that we are somewhere near the bottom. There’s increased supply from domestic fracking and OPEC’s inability to put a freeze on production. Combine this with a slowdown in demand from China, and prices have taken a dive over the past couple years. Oil isn’t going anywhere though, and it’s a great time to get in while it’s cheap.

From gas and diesel, to jet fuel, heating, propane, plastics, clothing, furniture, and even food, oil is used for just about everything we produce. Whether the economy picks up in the next few months, or the next few years, it’s a safe bet to expect oil to rebound significantly as demand increases.

Price of a barrel of oil, 2008 - 2016
Price of a barrel of oil, 2006 – 2016

It would be wise to implement a dollar cost averaging strategy with many of the investments listed below. This way, you don’t have to fret over whether we’re at the bottom yet. To learn inexpensive ways to execute DCA and avoid commission fees, read “4 Ways to Dollar Cost Average on a Limited Budget“.

Let’s take a look at some strategies you can implement today.

Invest in Commodity-Based Oil ETFs

BTB Picks for Oil ETFs:

USO – United States Oil Fund

USO is the largest oil ETF, with a market cap of over $3 billion. This makes the USO a highly liquid fund and good for trading. Like many oil based ETFs, USO is at an all time low, down 92% since its high in mid 2008. Unlike a company’s stock that could in theory go bankrupt, commodities, and in particular oil, cannot. When it does rebound, so will the price of USO.

UNG – United States Natural Gas Fund

UNG is another highly liquid fund with low fees. This ETF focuses on the U.S. oil market, which may be attractive to some investors as the U.S. market is simpler to understand than the global oil markets.

DBO – DB Oil Fund

DBO is a PowerShares fund, and while it has slightly higher fees, it will track changes in the market value of light sweet crude oil very well. Take a look at the DBIQ Optimum Yield Crude Oil Index if you’d like to see the underlying index.

Indirectly Invest in Oil Through Energy Companies or Energy Funds:

Investing in energy companies or funds will diversify your risk, as your investment won’t be tied exclusively to oil. Energy is needed to power the global economy, and most energy today is derived from crude oil. While there has been a slowdown in China, its scope has been overstated, and the nation is projected to produce the largest GDP within 10 years. Additionally, India is finally modernizing its economy, and has even more growth potential than China.

With oil making up a large portion of many energy funds, you will do well when oil prices increase and have the additional benefit of alternative energy sources in the mix. Energy funds are tied to oil, solar, wind, and other alternative energy sources and are not reliant on one company pulling the all the weight. They are also immune from poor management decisions or financial troubles. There’s not as much upside as with going directly with an energy company, but the funds are a safer option for those who are risk averse or who can’t afford a substantial loss.

On the other hand, using energy companies to gain access to oil is a mixed bag. If you can handle the risk, investing directly in company stocks can pay off big, but you also run the risk of loosing most of your investment if the source dries up or the company faces financial trouble.

BTB Picks for Energy Companies:

KMI – Kinder Morgan

There’s a reason Warren Buffet bought $396 million worth of shares in Q4 2015 alone. Buffet has always been one to seize an opportunity to buy a stock or sector that is undervalued, and following his lead is usually a good bet. KMI is mostly involved with North American infrastructure related to oil and gas. The company has a stronghold on the U.S. market, as a third of natural gas that moved through the U.S. in 2014 did so through a Kinder Morgan asset. Hydraulic fracturing has been steadily increasing in the U.S. for years, and while the future of the market is somewhat dependent on political policy and the upcoming election, the industry is strong.

KMI is down 61% since its high less than a year ago, and pays a tidy quarterly dividend as well.

HAL – Halliburton Company

Halliburton is a household name, and for good reason. The company has been around since 1919 and has operations worldwide in over 80 countries. Halliburton provides the equipment needed for oil extraction, but is also diversifying and getting into energy analytics. With a decent dividend yield and nice upside when oil rebounds, Halliburton is a solid pick if you’d like direct exposure to an energy company.

XOM – Exxon Mobile

Investing in Exxon is a bit different than the previously mentioned stocks because the company can do well whether oil prices increase or not. It operates on the production side, so a rise in oil prices means increased revenues. Additionally, it benefits from the downstream process as it sells refined products like gas and diesel, so low prices mean increases in the consumer side of the business. Exxon is currently the 4th largest U.S. company by market cap, so it’s doing something right.

exxonmobile_BTB

BTB Picks for Energy Funds:

XLE – Energy Select Sector SPDR

XLE is by far the largest energy sector ETF by market cap at over $11 billion. The fund tracks the Energy Select Sector Index, which is comprised of oil, gas and combustible fuels as well as related equipment and services. This is a sector fund, so keep in mind that while it is more diversified than an individual stock like KMI or XOM, it’s still generally more volatile than a broad based ETF like SPY.

NANR – SPDR S&P North American Natural Resources ETF

NANR is not strictly an oil and gas ETF. Instead, it tracks mid to large-cap U.S. and Canadian natural resources and commodities companies. Most of the fund is comprised of companies dealing in energy, materials and agriculture. NANR benefits from gains in oil, but has other assets that make it a more diverse option.

IEO – iShares U.S. Oil and Gas Exploration and Production ETF

IEO is the most bullish energy fund on the list. This is because the ETF tracks the Dow Jones U.S. Select Oil Exploration & Production Index composed of domestic equities in the oil and gas exploration and production sector. Exploration and production ETFs are a bit more speculative than something like XLE, but that can pay off in a big way if oil demand picks up.

The Short-Term Play:

UWTI – VelocityShares 3x Long Crude Oil ETN

If you strongly feel oil is going to rebound soon and sharply, UWTI is a 3x leveraged ETN that is the highest risk/reward option on the list. It’s highly volatile and trading at an incredibly low nominal share price of about $1.50 a share at the time of this writing. It’s quite a spectacle, as there has been an incredible amount of volume over the past few months indicating a large amount of speculation around the fund. This ETN should only be used by experienced investors or those willing to take on substantial risk. Read about the use of leveraged ETFs: “Can Leveraged ETFs be used as Part of a Buy and Hold Strategy“.

Final Thoughts on Investing in Oil:

Remember that oil is a commodity and should represent only a portion of a well-balanced portfolio. Read about asset allocation and portfolio building here.

There are many ways to get a piece of the oil action in today’s markets. For those who want to take the safer route, diverse energy exchange traded funds are the way to go. On the flip-side, investors who are confident oil will bounce back and are willing to take on slightly more risk, investing directly in an energy company or a more narrow oil based ETF is a solid choice.

-Brian

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2 thoughts on “How to Invest in Oil: A Comprehensive Guide

  1. James

    Good post. I agree with most of your picks but personally I would stay away from UWTI. Seeking alpha had a recent article about a company called Silver Run Acquisition. This company just IPO’d and is taking advantage of low oil prices by buying up distressed companies in the energy sector. It’s a unique IPO, you should check it out (SRAQU).

  2. Michael

    The news media has been touting oil as a weak investment right now. I take the contrarian approach, and agree with you that now is the time to buy. I already have a diverse commodities pool etf in my portfolio now – DBC. I’m going to be adding oil over the next three months and will probably go with USO. Oil could conceivably go as low as $20 or so a barrel, but it’s just unrealistic to think it wont rebound. The downside risk is not nearly as strong as the potential gains, especially long term.

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