Risks and Rewards of Investing in Oil Company Stocks
The Energy stock market offers a wide range of investment opportunities including oil and natural gas stocks and ETFs. Investing in oil stocks can, however, be tricky. The demand for oil and natural gas is stable and growing, despite the growing use of renewable energy. Most countries across the globe are highly dependent on petroleum and its byproducts to carry out their day-to day business.
On the other hand, oil prices are very volatile. At the beginning of 2018, the prices of oil stocks were double what they were in 2016. This is why it is crucial that investors study the risks, the rewards, and should aim to have a balanced investment portfolio. Here's a look at the top risks and benefits of investing in oil company stocks:
Oil prices are very sensitive to supply and demand, and if you are planning to add, for example, BP oil stocks or Shell oil stocks to your portfolio, a number of factors need to be taken into consideration.
Market Price Volatility
The prices of oil stocks are volatile, making it is risky for investors to tie up a large percentage of their resources without adequate research. Price volatility in oil company stocks depends on a number of geographical, political and economic factors. For instance, recent political instability in the Middle East had a significant impact on the price of oil stocks.
When considering to invest, whether it is in natural gas stocks or petroleum stocks, you should conduct thorough research about the company and its projects. This might give you an insight into what to expect from the company in the future.
A large number of frauds have taken place in the past within the oil industry. You may have witnessed incidents where people invested in oil company stocks, only to realise that it was a scam and no such company actually existed. Or, the predictions about their exploration projects were exaggerated. Proper market research about the company, its products, oil wells, and exploration needs to be conducted before investing in the stocks.
Political Risk and Instability
Politics has been a regulatory force when it comes to oil and natural gas. Risks increase when companies are working on exploration within unstable territories. Usually, oil companies invest in stable states, but ultimately, they need to go where the oil and the gas is. A sudden political turnaround and change in the policy of governments can have a significant impact on projects.
Before investing in oil stocks, make sure that the company doesn't operate in countries with unstable dictatorships or a history of sudden nationalization. One area to take under consideration is the partnerships an energy firm has with international oil companies and agencies.
Extraction of oil and gas is difficult due to the terrain and the possibility that the predicted size of the reserves was incorrect. Oil and gas geologists use "proven," "probable" and "possible" as terms to estimate the success of drilling. As an investor, ensure that you thoroughly study research reports by geologists before investing in oil stocks backed by active drilling projects.
Oil Spill and Fire Accidents
Oil spills and fire accidents on exploration sites of oil companies can lead to crashes in stock prices. In 2010, the world witnessed one of the worst oil spills and fire accidents on a deep ocean exploration site. 'Deepwater horizon' (also known as the BP oil spill) took place in the Gulf of Mexico.
This incident is considered to be the largest oil spill in history, and led to BP stock prices plunging and investors suffering huge losses as a result. The incident also led to the death of 11 people and about 5 billion barrels of oil spilling into the Gulf of Mexico, demonstrating how risky the sector can be.
Return on Investment
Energy stocks, like petroleum and natural gas stocks, attract a lot of investment, since they offer lucrative returns on investment, albeit with losses as well. Technological advancement in the field of drilling in both proven conventional fields, and unconventional shale, have changed the dynamics and lowered the risk of investing.
Prices of the stocks of oil companies usually witness a steep rise when drilling leads to the discovery of massive oil fields. Oil fields last for years and start earning profits within a year of exploration. These oil stocks may provide a stable source of income, although they may come with periodic losses and risks.
Investment in energy sector stocks offers some tax benefits. A major chunk of the income from these stocks is tax sheltered.
Investment in oil stocks provides a good means of diversification against the overall economy. When the price of oil and gas rises, economies may witness a slowdown, where other stocks and instruments may witness losses. To balance the outcome of an economic slowdown, you could consider investing in oil and natural gas stocks for stability. It may also provide insulation against fluctuating market conditions and inflation.
Tips for Investing in Energy Stocks
You can invest in energy stocks in a number of ways, including:
- ETFs and Mutual Funds: These provide substantial exposure and diversification without direct risk in terms of commodity spot prices, and without putting a chunk of your wealth on the performance of a single company or product. There are plenty of petroleum and natural gas ETFs to choose from.
- Large Market Cap Stocks: Crude oil stocks with large market cap provide stability and lesser exposure to market fluctuation. You may consider stocks of oil companies such as Royal Dutch Shell, British Petroleum (BP), and China Petroleum & Chemical Corp. Each of these companies engages in various sectors of exploration of oil, shale oil, natural gas and more.
- Futures Contracts: You can purchase derivatives, such as future contracts in oil and natural gas. It can be a risky investment given that there are chances that future contracts won't yield any returns.
The Importance of Market Research
Before investing in any instrument related to oil, consider studying the underlying asset. Regulations and changes in policy play a major role, so keep an eye on the changing policies and political situations to make the most of it, and prevent major losses.
The prices of oil stocks are highly volatile and depend on various factors. Despite efforts to adopt renewable energy, the demand for oil and natural gas remains high. And while there are associated risks when you invest in the stocks of oil companies, there is also potential for good returns on investment, while also offering diversification to your portfolio. Make sure to implement risk management strategies into your investing, in order to effectively manage the risks.
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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.