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An Oil Buying Guide for Novice Investors

by Nina Smith

Have you just entered the world of investments and wondering would it be a good idea to buy oil? If yes, then you must know that investing in oil may involve several complex steps. In this article, we have discussed the factors you must keep in mind before using your hard-earned money to buy oil. You can click here to learn more about buying and selling oils before reading this write-up.

An Introduction to the Industry and Product

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Before you start investing in petroleum, you must understand why it is such a big commodity. Petroleum or crude oil is first extracted by excavating the earth. The extraction process involves the use of large oil rigs. The oil is then refined using a series of procedures. This results in the production of a range of petroleum-based products including gasoline.

Petroleum is such a big commodity around the globe primarily because of the wide array of purposes it can be used for. Other than serving as the base for fuels like gasoline, diesel, etc. petroleum is also used to manufacture the following products:

  • Paint
  • Perfume
  • Deodorant
  • Refrigerant
  • Hair color, and more

Supply and Demand Play Major Role in Deciding the Price of Petroleum

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The scientists have still not managed to come up with a substitute for petroleum. This means the world is still highly dependent on this creation of nature. The absence of any substitute makes it mandatory for us to rely heavily on the natural supply of crude oil for making the above-mentioned products.

The high demand for crude oil and the limited supply of the same make petroleum an extremely hot commodity. As the demand will only increase in the future and the supply will only reduce, investors expect the oil price to keep rising with every passing day. When there’s an increase in the price of petroleum, the investments of shareholders increase automatically.

About Beginning Your Investment

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You can adopt three different ways to invest in oil or the petroleum industry. Read on to know about them.
Oil ETFs: Mutual funds, stocks, and ETFs (exchange-traded funds) are some of the simplest and fastest ways to begin investing in petroleum. As a beginner, you should primarily focus on investing in ETFs. This is one investment route that has direct links with the oil price. ETFs will provide you with access to multiple assets at the same time and also diversify your portfolio.

The process of buying and selling ETFs is the same as those of general stocks. The only difference is that the former will divide the investment into different stocks. These may include company stocks, derivative contracts, futures that track the price of oil, etc.

Oil Futures: Your chances of making a good profit from the commodities market will be pretty high if you invest in oil futures. For beginners in the world of investments, oil futures play the role of derivative securities, which provide them (the investors) the power to buy petroleum for a pre-decided price within the settlement date. You’ll be earning a good amount by selling the futures to another investor when the price of crude oil increases.

DPP: The next option you have is investing in oil well via DPP or direct participation. This investment vehicle will help you to invest directly in the exploration or production of gas and oil. The two most prominent benefits offered by DPPs are tax advantages and cash flow.

Consider opting for this investment tool if you are ready to lose some money. That’s because DPP requires a significant amount of due diligence and exposes investors to significant risks.

When you are investing in DPP, you are purchasing a certain percentage of an oil company’s interest and assets. You’ll have no role to play in the process of setting up the company. What’s more, you’ll be enjoying all the benefits of being a shareholder of the company without being involved in any of its operations. This phenomenon is usually referred to as “working interest”.

A profitable DPP investment can provide you with a steady cash flow. However, you should be ready to face losses if the oil company performs badly. DPP programs can be of four different types; they are:

  1. Working interest programs
  2. Exploratory drilling programs
  3. Developmental drilling programs
  4. Rework programs

Key Benefits of Investing in Oil

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The past few years have seen even small investors invest significantly in oil. That’s because this mode of investment exposes people to a wide range of advantages.

The first one of them is surely the excessively high-profit margins. Whenever a deep well exploration will hit a new oil reserve, you’ll see your profit margin skyrocketing. You can expect the returns to be five or even 10 times higher than the money you invested initially. Usually, abundant oil reserves start to bring in profits around two to three months following their discovery.

You should look to invest in oil also because it will help you diversify your portfolio. A duly diversified portfolio that includes different kinds of investments including oil will keep you protected even when stocks perform badly. That’s because the market prices of oil and gas are usually reversely proportional to economies. To put it more bluntly, if you invest in oil, you’ll be ready to face a serious economic slowdown as that moment will most likely coincide with a rise in the price of gas and oil.

People investing in oil and gas will also enjoy tax advantages. The tax advantages will be even more prominent if you choose to make investments in limited partnerships. You can expect as much as 15% of the shares you have to yield tax-sheltered earnings for you.

Final Words

Before you invest your money, always gather enough information about the oil company you are looking to invest in. Other than assessing their reputation, you should also read through the content of the contracts carefully and comprehend their terms.

As a beginner, you should also compare the benefits and risks associated with a particular venture before putting in your money. You must remember that although speculative projects can bring in greater ROI (return on investments), they tend to be extremely risky. So, invest in them only if you can afford to incur a loss.