How to Invest in Oil: Stocks, Funds, and Futures

Oil remains a fundamental commodity that underpins various facets of the global economy, serving as a primary energy source and a crucial raw material for numerous products. Its pervasive influence extends from transportation and manufacturing to the production of plastics and chemicals. The global demand for oil, coupled with its finite nature, contributes to its ongoing relevance as an investment consideration. Understanding the various avenues for engaging with this commodity can provide investors with different levels of exposure to the energy market.

Investing in Oil Company Equities

Individuals seeking to invest in the oil sector can acquire shares of companies directly involved in the industry. This process begins by opening a brokerage account, which allows the purchase and sale of various securities. Once funded, investors can research and buy stocks of oil and gas companies through the brokerage firm’s platform. Many online brokerages facilitate this type of investment.

Oil and gas companies operate across different industry segments, each with distinct functions. Upstream companies, also known as exploration and production (E&P) firms, identify deposits, drill wells, and extract raw materials. These companies often face significant capital requirements and geological risks.

Midstream companies handle the transportation and storage of crude oil and natural gas, utilizing infrastructure like pipelines and shipping vessels. Their operations are often characterized by long-term contracts, which can provide stability.

Downstream companies refine crude oil into usable products like gasoline, diesel, and heating oil, then market and distribute them. This segment includes petrochemical plants and retail outlets.

Some large corporations are integrated oil and gas companies, participating in multiple segments like upstream, midstream, and downstream operations. Oilfield services companies provide specialized equipment, technology, and support for drilling and well construction. When considering specific oil company stocks, investors evaluate a company’s primary business focus within these segments, as each area presents unique characteristics and market exposures.

Investing in Oil-Linked Funds

Investing in oil can also be achieved through various types of funds that provide exposure to the commodity or the companies involved in its production. Exchange Traded Funds (ETFs) are popular instruments that trade on major stock exchanges, offering convenience and liquidity. Oil ETFs can be structured in different ways: some invest directly in oil futures contracts to track crude oil prices, while others hold a basket of stocks of oil and gas companies. This distinction means some funds aim to mirror commodity price movements, while others represent an investment in oil-related businesses.

Exchange Traded Notes (ETNs) are another investment type, structured as unsecured debt obligations issued by a bank. Unlike ETFs that own underlying assets, ETNs promise returns linked to an index or commodity, such as oil, but do not hold the physical commodity or its futures. Mutual funds specializing in the energy sector offer a diversified approach to oil investment by pooling contributions to buy shares in various oil and gas companies. These funds provide indirect exposure to the oil industry without requiring investors to select individual stocks.

All these funds can be purchased through a standard brokerage account. A key difference between funds that invest directly in the commodity (via futures) and those that invest in oil company stocks lies in their underlying assets and how they are taxed. Futures-based funds, like the United States Oil Fund (USO), aim to track crude oil prices, whereas equity-based funds invest in energy corporations. While ETFs and ETNs offer tax advantages over mutual funds by deferring capital gains until shares are sold, investors should be aware of potential tracking error in futures-based funds, where the fund’s performance may not perfectly align with the spot price of oil.

Investing in Oil Futures and Options

For investors seeking more direct engagement with oil price movements, futures contracts and options offer advanced avenues. An oil futures contract is a standardized legal agreement to buy or sell a specific quantity of oil at a predetermined price on a future date. These contracts obligate the buyer to purchase and the seller to deliver the underlying commodity at the agreed-upon price when the contract expires. Futures trading involves inherent leverage, meaning traders control a large contract value with a smaller initial deposit, known as margin. This leverage can amplify both potential gains and losses.

Trading oil futures occurs on specialized exchanges, such as the New York Mercantile Exchange (NYMEX) or the Intercontinental Exchange (ICE). Investors need a brokerage account that allows for derivatives trading. Futures contracts have specific expiry dates, after which the obligation to buy or sell oil must be fulfilled, either through physical delivery or cash settlement. Standard crude oil futures contracts often represent 1,000 barrels of oil, while micro contracts exist for smaller exposures, such as 100 barrels.

Options contracts related to oil provide the holder with the right, but not the obligation, to buy or sell oil futures at a specified price, called the strike price, before a certain expiration date. There are two main types: call options and put options. A call option grants the holder the right to buy the underlying oil futures, used when an investor anticipates a price increase. Conversely, a put option gives the holder the right to sell the underlying oil futures, utilized when an investor expects a price decline.

The buyer of an option pays a premium for this right, which represents the maximum potential loss. If the oil futures price does not move favorably by the expiration date, the option may expire worthless. Options are also traded on specialized exchanges, and their underlying asset is usually an oil futures contract, not physical oil itself. The selection of a strike price and expiration date is important for options traders, as these factors significantly influence the contract’s value and potential profitability. While options offer flexibility due to the “right, not obligation” feature, they still involve careful analysis of market conditions and price expectations.