Investing in oil. An introduction

Investing in oil. An introduction

Where would the world be without oil? This is a question that can’t even be answered. We can say that the world economy is completely dependent on oil and the products made from it. Oil is the raw material for making fuels, lubricants and paints, but also for products made of plastic and many other materials.

WTI (West Texas Intermediate) vs Brent Crude

A distinction is made between two types of oil: West Texas Intermediate Oil (WTI) and Brent Crude Oil. WTI oil comes from wells in the United States (mainly Texas and Louisiana) and Brent Crude oil comes from wells in the North Sea. Most oil is priced with Brent Crude oil as the benchmark. The prices of WTI oil and Brent Crude oil can differ from each other for various reasons. Brent Crude oil is easier to transport because the oil wells from which Brent Crude oil is extracted are close to the mainland. Furthermore, political and economic developments have a direct influence on oil prices.

In this article we describe the most important factors that determine the oil price and explain how to invest in oil.

What’s moving the oil price?

The price of oil is determined by supply and demand. When the demand for oil rises, or the supply of oil falls, the price will rise. Conversely, the price of oil will fall. So when we want to assess the current oil price (or a future oil price), we need to know what influences the supply of and demand for oil. These are the following:

New discoveries oil fields

Oil companies are still looking for new oil fields. New oil fields can bring in a lot of money, but can also put some pressure on the oil price due to an increase in supply.

The state of the world economy

The year 2020 is dominated by the corona crisis. Economic activity is much lower than normal and almost all countries announce an economic decline of several percent. The prices of crude oil have plummeted and at one point were even negative for a while. Oil is an important raw material for the production of many goods. When the demand for goods falls, it will have a direct impact on the price of oil.

Speculation

Speculators use so-called derivatives to predict the future price of oil. Speculators therefore do not invest in oil itself. The value of a derivative is derived from the price of an underlying asset, in this case oil. Futures contracts are usually used to speculate in oil. Large numbers of futures contracts have an influence on the price of oil. When large numbers of futures contracts are bought at a price above the current market price, this can cause the price of oil to rise.

Inflation

When the price of oil rises, so will the price of many goods. One of the ways to protect yourself against inflation, is by investing in oil or other commodities. However, this can lead to a rise in raw material prices, which in turn can lead to a further rise in the prices of goods.

The weather

You can imagine that during cold winters the demand for heat, and therefore oil, rises. This is an example where the demand for oil causes the price of oil to rise. Globally, we are seeing more and more extremes in the weather, which influence the demand for oil. Extreme weather can also have a major influence on the production of oil.

The OPEC

OPEC (Organization of the Petroleum Exporting Countries) is a group of the 14 largest oil exporting countries. OPEC coordinates the joint oil policy and tries to ensure stable oil production. OPEC’s actual goal is to control the oil price and prevent excessive price fluctuations.

Geo-political developments

Political developments and tensions can have a major impact on the price of oil. Some of the countries that are part of OPEC are: Iran, Iraq, Kuwait, Saudi Arabia, Venezuela, Libya, Algeria and Nigeria. Given the tensions in the Middle East and the political and economic situation in Venezuela, for example, you can imagine that it is not easy for OPEC to implement its policy successfully. Also, disagreement within the countries that are part of OPEC is not uncommon.

American oil reserves

America is one of the countries that holds a large supply of oil. Depending on the state of the economy, this stock can be increased or decreased. Large stocks will not immediately cause price changes when OPEC reduces the supply. However, if the oil supply in the United States is low, then any change in the supply of oil will cause price changes.

Alternative energy sources

Alternative energy sources have been emerging for many years. Oil will run out as a fossil fuel and is also very harmful to the environment. In the long run, the supply of alternative energy sources may lead to a decrease in the demand for oil.

Ways to invest in oil

Physically investing in oil by buying a number of barrels of oil and waiting for a price increase is irrelevant. Fortunately, there are a number of other ways to invest in oil.

Oil shares

The most common way to invest in oil is by buying shares of oil-producing companies, or companies operating in the oil sector such as exploration companies and oil storage companies. Some examples are Royal Dutch Shell, Chevron, Exxon Mobil and Royal Vopak. The large listed companies in the oil sector have a stable track record and a constant dividend flow. Because these companies are so large, they are followed by many analysts and a lot of information is available. Shares of companies in the oil sector can be highly volatile, which means that the share price can fluctuate considerably.

Investment funds and ETFs

Investing in funds or ETFs (Exchange Traded Funds) offers investors the opportunity to invest with greater diversification in the oil sector. Please note that in practice there are many different ETFs available, which invest in different ways in the oil sector. The risk will therefore vary from fund to fund or ETF to ETF. For example, an ETF may contain companies that produce oil, but an ETF may also follow futures contracts or other strategies to invest in the oil sector.

ETF stands for Exchange Traded Fund. The annual fee charged by providers of ETFs is approximately 0.4 per cent. ETFs are therefore a simple and cost-effective way to invest in oil. As ETFs are tradable via exchanges, buying and selling is quickly possible.

Investing in oil with leveraged products

It is also possible to invest in oil with so-called leveraged products. These are products that are derived from an underlying asset, as a result of which they are also referred to as derivatives.

Leverage products are known for their leverage effect. Leveraged products involve a position in which the value of the position reacts more strongly to a change in the price of the underlying asset than if it were invested directly in the underlying asset. In the case of a leveraged product, the investor only funds part of the total underlying asset or position size. The greater part of the position size will be financed by the provider, who will charge a financing fee for this. The major advantage of leverage products is that relatively large results can be achieved with a small amount.

Profits and losses are based on the total value of the position. It is therefore important to deal responsibly with leveraged products. In addition, it is important to always provide positions with a so-called stop loss. A stop loss is an automatic order that an investor uses to limit the maximum loss of a current position. In this article you’ll be able to read how to use a stop loss in online trading.

A number of products in which you’ll be able to invest in oil with leverage:

  • Oil options
  • Oil Turbos, Oil Sprinters and Oil Speeders
  • Oil futures
  • Oil-CFDs

It goes without saying that the use of leveraged products to invest in oil requires some knowledge and will not be the first choice for a novice investor.

Conclusion

It is mainly large parties in the oil market that determine the market. This also applies to oil investments. We have seen that there are several ways to invest in oil, each with its own characteristics and risks. This is not for nothing. Oil is indispensable in today’s economy and this will continue to be the case in the future. Try to determine which way of investing in oil is best suited. Investing in ETFs is the most common way.

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