How Do I Invest in Oil Commodities or Stocks?

Investors can express their convictions about oil price movements by purchasing stock in companies that are involved in the oil "value chain," include companies that drill for oil, trusts that own the rights and collect royalties from oil-rich properties, oil refiners, firms that transport petroleum products and marketers of fuels and byproducts. Investors can also buy exchange-traded notes that are contractually linked to oil price or exchange-traded funds that hold oil futures, each of which more directly benefit from oil price appreciation.

Step 1

Forecast trends in oil prices. Predicting future oil prices can be difficult. Supply can increase based on new investment in oil prospects, the development of new technologies and the availability of substitutes for oil consumption, such as natural gas, hybrid cars and telecommuting. Demand can increase as world incomes rise and more people buy cars that run on petroleum oil products. Rising demand leads to higher prices, and higher supply leads to lower prices. Increasing oil inventories are typically thought of as bearish for oil prices; declining inventories are considered bullish. Speculators and investors also participate in the oil markets, and these participants are not driven by supply and demand but on investment conviction. This means that supply and demand do not reliably drive the price of oil, as other interests are involved.

Step 2

Determine how actively you want to invest. If you do not want to research many different companies, buying an oil fund would be more appropriate. If you want to pick stocks, direct purchases of oil companies are appropriate.

Step 3

Perform fundamental analysis if you are investing in funds. Seek low fees to keep more returns from the fund's holdings. Select exchange-traded funds over traditional open-end mutual funds, because ETFs are more tax friendly. Because commodity prices tend to outperform commodity stocks, you're better served by funds with oil futures holdings than funds with oil stock holdings. Seek an oil futures exchange-traded fund or an oil exchange-traded note.

Tip

  • Perform fundamental analysis if you are picking stocks. Greater reserves and lower per barrel production costs make downstream, oil producing companies more attractive. Higher gross and operating margins make upstream oil companies more attractive.
  • Since oil is subject to huge swings in price, the price multiples of oil stocks should be below the stock market averages for price multiples to compensate for this risk. Do not buy oil stocks at richer price multiples than those of noncommodity stocks.
  • You can research and invest in the stock of companies that have large fuel expenses like airlines if they have negative forecasts for future oil prices. Perform fundamental analysis on these stocks as well.

Warning

  • Commodity stocks have historically underperformed the returns on commodities themselves.

Photo Credits

  • Comstock Images/Comstock/Getty Images

About the Author

Joe Escalada is a financial analyst. He earned a Master of Business Administration from the University of California at Davis and has passed all three Chartered Financial Analyst examinations. He has a bachelor's degree from the California Institute of Technology.

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