How to Buy Oil Stocks
Some of the world’s wealthiest people (past and present), such as John Rockefeller, Jean-Paul Getty, and the Koch brothers, have made their vast fortunes by investing in oil or setting up their own oil companies.
If you also want to take advantage of the movements in oil market prices and potentially make investments in shares of oil companies, then you are in the right place! In this article, we will look at the different types of oil companies, why people invest in them, how to buy oil stocks and much more!
What Is an Oil Company?
The world’s population and economy are continuously growing and with it the demand for energy. The role of oil companies is critical in supplying this demand.
An oil company is a company which operates in the oil industry. Their business activity could be related to exploration, production, transportation, refining, petroleum product sales or services to the oil industry. An oil company may operate in more than one of these segments of the industry.
Some interesting facts about the oil industry:
- The earliest recorded oil drills in China date from 347AD
- Spain made famous the distillation of oil in Europe in the 12th century, followed by Romania
- EW Binney & Co was the world’s first oil company, founded in Scotland
- Pittsburgh, Pennsylvania, in 1853, was the location of the first oil refinery in the United States.
- In 1870, John Rockefeller founded the famous Standard Oil company
- In 1911 Standard Oil was declared a monopoly and split into 34 smaller companies, including today’s giants: ExxonMobil, Chevron and Marathon Petroleum
Types of Oil Companies
As we have mentioned above, not all oil companies are the same and they can operate in entirely different sectors of the oil industry.
Investors need to know the specifics of the oil sector in which they invest. It is essential to be aware of a particular company’s role in the oil industry because it can significantly impact its profits.
The main types of oil companies include:
- Upstream companies include oil exploration and production companies. They are the most vulnerable to fluctuations in oil prices. One example of such a company is ConocoPhillips
- Midstream companies transport, ship or store oil. These firms often work with long-term fixed-rate contracts, and their operations are, in some ways, isolated from fluctuations in oil prices. One such company is Enterprise Products Partners
- Downstream companies process oil into other petroleum products or sell refined products to the end-user. Some do both. Companies with refineries and retail petrol stations are a typical example of such companies, for example, Phillips 66
- Integrated companies are those which operate in more than one of the sectors mentioned above and quite often in all three. Such giants in the oil industry include ExxonMobil, Chevron and Royal Dutch Shell
- Oil service companies are responsible for the equipment, operational maintenance and logistics of companies who operate at the top of the stream, Schlumberger is one example.
Let us explore how different types of oil companies make money:
An oil producer makes money by selling oil. It can generate significant profits when the price of “black gold” rises and is well above its average production costs. However, such companies have difficulty if circumstances create a sharp drop in oil prices.
At the same time, refiners and refineries typically buy oil from producers, which means they can earn more at lower oil prices, by selling higher volumes.
Companies that transport oil generate steady cash flows. These are the funds that remain after investing in asset maintenance and improvement. They can earn during good and tough times of oil prices because they collect fixed fees based on the amount of oil transported.
Upstream companies have the most significant potential to gain from rising oil prices, but, as is often the case, this opportunity comes with higher risks. Companies with the least volatile stock prices are in the middle of the flow.
Investors focus on investing in shares of companies from various oil industry sectors or choose integrated companies to attempt to manage the risks associated with investments in oil stocks.
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Why Invest in Oil Stocks?
The oil industry suffered a severe blow during the Covid-19 crisis, but problems had already surfaced before the pandemic - for example, the price war between Saudi Arabia and Russia. However, in recent months, recovery has been evident.
In January 2021, the International Energy Agency (IEA) predicted in their Oil Market Report that:
- Global oil demand would bounce back in 2021 to 96.6 million barrels per day, after an unprecedented decline of 8.8 million barrels per day in 2020.
- The IEA projects a supply increase by 1 million barrels per day in 2021 to 92.8 million barrels, after declining by a record 6.6 million barrels in 2020.
- Increased demand could raise oil prices as early as 2021 and higher prices could boost oil companies’ activity.
Here is what the Organization of the Petroleum Exporting Countries (OPEC) thinks about the development of the oil market in 2021:
Source: OPEC Monthly Oil Market Report - February 8, 2021
OPEC also expects oil demand to recover after the decline in 2020, with demand outstripping supply in 2021.
Besides this data on the future prospects of oil, other reasons why people may choose to invest in oil stocks include:
- Bank deposit rates in 2021 currently offer close to zero interest rates.
- Inflation can exceed interest rates on deposits.
- Ongoing stimulus programmes across the globe are increasing the money supply and exerting inflationary pressures.
- The opportunity exists for capital gains to achieve financial goals.
- Build passive income through annual share dividends.
- Diversify your asset portfolio.
- Extremely high liquidity properties: you can buy and sell oil stocks within seconds.
- The increased liquidity of oil stocks results in competitive transaction costs (spreads and commissions).
How Much Capital to Invest in Oil Companies
The answer to this question depends on three factors, which will be different for every individual:
- Financial capabilities
- Financial goals
- Tolerance for risk
Investment opportunities can be a personal experience for investors; therefore, it is impossible to determine the exact initial investment we feel comfortable making as individuals when we have goals as diverse as our characteristics.
You can consider your investment horizon or the time the funds get locked into an investment strategy without needing to access them. You must decide if you want to focus your attention on short-term or long-term investments.
Cumulative Investment: pledging a specific amount each month can result in small, regular investments developing into substantial long-term rewards. Such a method can be exceptionally dynamic when considering compound interest.
During this reflection process, you could begin to identify your financial goals. What are your plans, and how can you support these aspirations financially?
Do you plan to buy a house, upgrade your car, pay for a child’s university education or are you planning an exotic holiday? You may have the ambition to start or develop a business or be planning to have a comfortable retirement.
Answering these questions while identifying your ambitions will help you develop a plan to reach your financial goals.
Once you have identified your targets, you must establish your risk tolerance. Your ability to cope with risk will depend on factors such as your regular income, savings, expenses, financial obligations and adequate life and health insurance. Your temperament is also a factor affected by the above list.
An extended investment timeline with a low percentage return can result in a similar result to a short-term timeline with a higher return rate; ten years earning 2% per year provides similar rewards to five years at 4%. Both investments return just over 21% (including the compound interest). This simple illustration shows how different approaches can be applied to reach similar outcomes.
Risks of Investing in Oil Stocks
Like any investment, investing in oil stocks comes with risks. If you plan on adding the shares of oil companies such as ExxonMobil or Royal Dutch Shell to your portfolio, you must consider the following risks before doing so:
- Share price volatility - like oil prices and other stock prices, oil company shares are volatile. This feature makes them suitable for investors with a high-risk tolerance who pursue higher returns. Oil stocks are not as appropriate for more conservative investors.
- Political risks - changes in regulations for oil exploration and production, attempts to nationalise oil as a commodity, combined with the extraction in unstable regions are other issues that must be considered when buying shares in oil companies.
- Geological risks - extraction from some oil fields can become hampered by the terrain, leading to increasing costs and reducing an oil field’s profitability.
- Renewable energy - some countries worldwide are in the process of reducing their reliance on oil as part of their economy’s fossil fuel energy supply by launching various renewable energy initiatives.
- Oil spills and accidents - such incidents can lead to a decline in confidence in an oil company, leading to a drop in the sector’s stock prices.
You should bear in mind that the smaller and more focused the company, the more important the above risks can turn out to be; whereas the oil majors are, by their nature, more diversified geographically, politically and in terms of their span of businesses.
You can manage these risks with the right equity investment strategy and risk management plan.
How to Invest in Oil Stocks
To invest in the shares of an oil company, you need to have the right tools at your disposal.
The first step is to open a live trading account with a regulated broker, such as Admirals. Then download a financial market trading platform that gives you access to oil companies’ shares.
Once you have selected a broker and a suitable trading platform, it is time to consider the various financial instruments that can allow you to gain exposure to the oil industry.
The options for investing in shares of oil companies include:
- Investing directly in oil stocks
- Trading Contracts For Difference (CFDs) on the shares of oil companies
- Oil ETFs which include the shares of oil companies
Each opportunity has advantages and disadvantages. Individual investors must choose the right tools considering their capabilities, personal financial goals and risk tolerance.
Let us now consider the pros and cons of each of the three investment methods outlined above.
Investing in Oil Stocks
Stocks are a security which represent the ownership of a fraction of a company. “Shares” is the name given to units of stock.
For example, if a company has issued one hundred shares and you buy ten shares of that company, you own 10% of the firm. Holding shares can give you (but not always) any of the following rights:
- Right to a dividend
- Right to vote at the general meeting
- Right to liquidation share
Most companies issue and sell shares to raise capital to finance their activities.
Advantages of investing in shares:
- You get ownership of the financial product with the associated property rights
- No swap fees or charges to keep the open position overnight
- More stable regulation
Disadvantages of investing in shares:
- Inability to open short positions
- More difficult to leverage
- Fees and commissions applied to both purchase and sale
Here is an example of a price chart for ConocoPhillips, one of the largest global oil companies operating at the top of the stream:
Depicted: Admirals MetaTrader 5 - ConocoPhillips Weekly Chart. Date Range: 11 October 2009 - 19 April 2021. Date Captured: 19 April 2021. Past performance is not necessarily an indication of future performance.
Oil Stock CFDs
A CFD represents a contract between a trader and a broker agreeing to exchange the difference in the price of an asset between the start of the contract and the time at which it is closed.
CFDs allow traders and investors to speculate on the price of financial instruments without ever physically owning the underlying asset.
The advantages of trading CFDs:
- Short sales - traders can potentially profit not just from rising prices, but also from falling prices
- Use of leverage - CFDs provide traders with access to leverage, enabling them to control larger position sizes
- Opportunities for day trading - with CFDs, you can take advantage of short-term price movements in stock, index or commodity markets
- Access to global markets - effortlessly trade a wide variety of financial instruments, such as stocks, bonds, currencies, commodities and cryptocurrencies through your chosen broker
- CFD trading with Admirals often attracts no fees and commissions for opening and closing positions
CFDs also have their drawbacks:
- No ownership of the underlying asset and no property rights if the company becomes bankrupt
- The leverage effect can be a double-edged sword; in addition to increasing potential profits, leverage also increases potential losses
- Swap fees to hold the position overnight
Below is a price chart of CFDs for shares of one of the largest integrated US oil companies in the world - ExxonMobil:
Depicted: Admirals MetaTrader 5 - Exxon Mobil Corp Weekly Chart. Date Range: 11 October 2009 - 19 April 2021. Date Captured: 19 April 2021. Past performance is not necessarily an indication of future performance.
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An ETF is a basket of securities that are bought and sold like shares on the stock exchanges via a broker. An ETF tends to represent an asset, sector or economy.
Oil ETFs represent an alternative option for investing in the oil sector and allow investors to gain exposure to a number of different assets with a single investment.
The advantages of investing in oil ETFs:
- Portfolio diversification - you are buying a basket of stocks, rather than just one.
- Lower costs - you can buy a basket stocks with the transaction costs associated with buying only one type of stock.
- ETFs can have lower liquidity than equities
- There can be discrepancies with the underlying asset that the fund is attempting to track
Below is the price chart for one of the most popular ETFs which contain oil stocks - SPDR S&P Oil & Gas Exploration & Production ETF (#XOP).
Depicted: Admirals MetaTrader 5 - SPDR S&P Oil & Gas Exploration & Production ETF Weekly Chart. Date Range: 11 October 2009 - 19 April 2021. Date Captured: 19 April 2021. Past performance is not necessarily an indication of future performance.
How to Choose the Best Oil Stocks
Investing and trading the shares of oil companies requires a diligent approach. Before investing in an oil-related instrument, consider exploring the underlying asset. Regulations and policy changes play a crucial role in the oil industry, so you must monitor any changes in either of these if you are planning to invest in the sector.
Despite efforts to switch to renewable energy, global demand for oil and natural gas remains high.
These factors could help you choose the best oil stocks:
- Diversification. It is preferable that the oil companies you invest in are conducting their operations in several countries and are also engaged in various industry-related activities.
- Low operational costs and less volatile cash flows can be a healthy indication. Exploration and production companies must demonstrate viability when oil prices fall below $40 a barrel.
- Mid-flow companies should receive more than 85% of their cash flow from permanent sources such as contract fees.
- Downstream companies should have below-average operating costs.
Pay attention to the dividend – concentrate on the amount, the dividend yield and payout ratio while comparing these metrics among different companies.
You can apply many other factors to compare various oil companies’ share performance. We have highlighted some of the most prominent which can form part of your fundamental analysis.
How to Invest in Oil Stocks
You now know what an oil company is, the different areas in which they operate, why investing in the shares of oil companies could be an attractive proposition and some of the different methods of investment available to retail traders.
We will now show you how, with Admirals, you can trade stocks, stock CFDs or ETFs:
- Sign up with Admirals
- Open a live account with Admirals. If you want to invest in stocks and ETFs, you will need to apply for an Invest.MT5 account. Alternatively - if you prefer the idea of trading CFDs on stocks, ETFs and a range of other financial instruments - you will need to apply for a Trade.MT5 account.
- Download the MetaTrader 5 trading platform
- Open your trading platform and head to the ‘Market Watch’ window on the left hand side of the screen, where you can search for your desired financial instrument - as shown below.
Depicted: Admirals MetaTrader 5 - Market Watch
- Once you have added the trading symbol to Market Watch, right click on it and select ‘Chart Window’ to open the price chart.
- Select ‘New Order’ from the toolbar at the top of the screen
- Fill in the trade volume (i.e. number of shares/CFDs) and enter a stop loss and take profit if desired.
- Click on ‘Sell by Market’ or ‘Buy by Market’
Depicted: Admirals MetaTrader 5 - Exxon Mobil Corp. Daily Chart - New Order. Date Range: 10 February 2020 - 19 April 2021. Date Captured: 19 April 2021. Past performance is not necessarily an indication of future performance.
Trade With the MetaTrader 5 Trading Platform
With Admirals, you can start trading oil stocks and many other financial instruments using the world’s number one multi-asset trading platform - MetaTrader 5! Download MetaTrader 5 now, completely free, by clicking the banner below:
Admirals is a multi-award winning, globally regulated Forex and CFD broker, offering trading on over 8,000 financial instruments via the world's most popular trading platforms: MetaTrader 4 and MetaTrader 5. Start trading today!
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.