Are you considering diversifying your investment portfolio by investing in crude oil? It’s clear that the world’s energy needs are changing, and sophisticated investors are putting in billions of dollars in the drilling of oil and reaping desirable results. Sometimes the prices of oil change even daily because of forces like supply and demand in the oil market. These fluctuations in oil prices can make it confusing to invest in the energy sector even for seasoned investors. What’s undeniable is that crude oil investment can help diversify your portfolio and act as a hedge against inflation.
How Demand and Supply Affect the Price of Oil
Like any other investment, the law of supply and demand plays a critical role in how much the commodity is worth in the crude oil market. Even though we depend on oil for everything from travel to heating oil, this demand is likely to change over time and affect oil prices. As more renewable energy solutions are discovered like solar and wind, this will impact oil’s supply and demand in the oil markets. Keep in mind that oil is a limited resource, which means that it will run out one day. This global panic about the precious commodity running out has made gas and oil companies that know where to find it become even more valuable.
In 2021, the Energy Information Administration (EIA) estimated the global demand for oil to be 98 million barrels per day. As more and more countries industrialize, this demand is expected to increase, leading to higher oil prices, especially in those growing emerging markets. There are certain markets that have set aside subsidies for their consumers as a way of spurring demand in their economies. However, sometimes these subsidies limit oil production, causing increasing supply and lowering oil prices. With increased oil prices, many refineries can focus on producing more refined petroleum products such as diesel and gasoline.
On the flip side, EIA reported that the global supply for oil in 2020 was at approximately 94.25 million barrels in a day. One of the main factors that have impacted its production each day is the fact that the number of new oil reserves found each year has been dropping since 2014. In fact, in 2017, the number of oil reserves discovered was the lowest it has ever been in almost 70 years. One main reason for the reduced discovery of new oil reserves is the fact that budgets for oil exploration have been cut with declined oil and gas prices. To date, the United States, Russia, and Saudi Arabia are the world’s largest oil producers.
Different Ways to Invest in Oil
There are different forms of oil investments, and the investment opportunity you pursue will be based on your unique needs.
Investing in Oil Futures
A common way to invest in oil directly is by buying oil futures. Futures contracts, although sometimes complex and risky, allow the buyer and seller to agree on a set price and a set date for the transaction. For instance, if you sign a futures contract with the oil seller, you can buy a given number of barrels of oil at a specific price on a set date. This helps to lock in the price, especially for companies with high oil consumption, such as manufacturing firms, where a significant change in oil prices can affect its profits. With oil futures, the buyer can secure a price for the raw material months ahead of time and maintain reasonable production costs.
Investors use oil futures as a way of buying and selling oil barrels at a profit. For instance, if you signed a futures contract with the oil seller that allows you to buy 1,000 barrels of oil at $100 in January 2022, and the price of oil increases to $150, you can buy the oil at the market rate and sell it at a profit. However, if the price drops, you won’t be able to sell it at a profit. The main advantage of futures contracts is that they are highly liquid with a potential of high degree returns.
Direct Participation Programs
Another option is direct participation in oil wells. In this case, the oil investment opportunity involves financing oil-related projects. For instance, investors can join a direct participation program (DPP) where they pool funds that are invested in projects such as oil drilling and extraction from a well. This means that by investing in the DPP, you own part of the oil company.
One thing you must understand with this kind of investing is that it’s a long-term investment opportunity, often 5-10 years or more.
Main advantages of direct participation programs:
· The long term investors can receive great tax incentives
· High ROI potential
· It generates passive income in the long-term
· Portfolio diversification
How Direct Participation Programs Work
If you invest in a DPP, you will own a percentage of the assets and interests of the oil firm. This allows investors to co-own a business without the stress of setting it up, being an expert in oil markets, or getting involved in the day-to-day management & operations of the business. There are different types of DPPs that most investors who are looking at direct oil investing can consider:
· Exploratory drilling program: This involves investors owning a part of a firm that drills wells in an already proven area. This comes with immediate tax write-offs which can help the investors save money every year.
· Exploratory drilling programs: In this case, the investor chooses a higher-risk kind of oil investing by partnering with a company that is exploring a new vicinity for oil fields. Exploratory wells can yield high returns, but there’s also a chance that they will produce little to no oil.
· Rework programs: In this case, the investor partners with an oil company that wants to improve production rates by re-working or revitalizing their existing wells. This can be done by drilling new zones, cleaning the wells, or re-stimulating.
Regardless of the DPPs you choose, oil investments can be very profitable for qualified investors if done right. You need to work with a reputable company that can guide you in choosing promising oil and gas investment opportunities with more tax incentives and assured returns.
Other Forms of Oil Investing
There are other forms of oil investing, such as buying mineral rights, purchasing shares of oil and gas companies, mutual funds, or EFTs.
Buying mineral rights
When you buy mineral rights to land that has oil, you could build your own operation to start extracting the resources, but this can be extremely difficult and expensive. Most people will sell or lease the mineral rights to gas and oil companies that specialize in the extraction of those resources and still own the land. Some landowners will even opt to receive royalties based on the amount of physical oil that is extracted from their resource-rich land. This gives them adequate cash flow. However, on the flip-side, mineral rights are very costly, especially for land that is known to be very valuable. You may pay for these rights and never receive the returns to cover all your costs especially due to changing commodity prices.
Purchasing shares of oil and gas companies
Another option is to invest in companies that specialize in oil production. Crude oil companies operate in different sectors, so you may have lots of investment types to choose from. However, investing in oil stocks can be risky since it depends on how the company performs. Additionally, investing in oil directly is likely to give you better returns than investing in individual oil stocks.
Buying oil mutual funds or EFTs
Unlike oil stocks which would mean that you lose your money if the company in question goes down, EFTs and mutual funds allow you to diversify your portfolio by getting access to hundreds of different stocks. Some mutual funds & EFTs focus on specific industries like oil, so you can identify one and buy shares. However, while there’s a risk reduction in this investment opportunity, your chances of more profits will also reduce. You also must pay a fee which further reduces your returns.
Advantages of Oil Investing
1. You get to diversify your investment portfolio with a commodity that is an essential part of our economy. Oil acts as a hedge against the drop in share prices of other companies. This is mainly because as oil prices increases, other sectors of the economy weaken.
2. Direct oil investing through a DPP has a high-profit potential. This is because projects like oil drilling can produce multiple times the cost in revenues.
3. You are likely to get high dividend yields since most of these oil companies have been around for many years. Investing in these blue-chip companies gives you an opportunity to generate passive income.
4. There are also tax benefits of oil investing. Oil companies enjoy certain tax benefits that are not accessible to other industries. For instance, an oil drilling company can deduct land depreciation from the land they own. If you have direct investments in this company through a DPP, you can benefit from these significant tax savings.
Oil is one of the most important commodities in the world. Investing in this commodity has the potential of generating significant profits while helping you to diversify your portfolio. We can help you to choose a suitable form of an oil investment opportunity that will allow you to gain value over the long term.
Want to learn more about oil investments and the energy sector in general? We’re here to help. We have an expert team that can provide you with all the information you need on the gas and oil industry. Schedule a consultation today to talk about diversifying your investment portfolio.