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Understanding Oil as an Asset
Crude oil is extracted from the earth using oil wells and refined into products that many nations around the world are reliant upon, such as petrol and diesel. Many countries like the United States keep large reserves of oil, which investors use to gauge trends in supply and demand.
Today’s globalized economy has an enormous fossil fuel demand, making oil is the most traded commodity in the world.
Like other commodity investments such as precious metals, oil trading is sensitive to inventory levels, production, global demand, interest rate policies, and aggregate economic figures such as gross domestic product.
Therefore, oil investments can be quite confusing for individual investors.
Why You Should Consider Investing in Oil
Oil is an economically and strategically vital asset. The IEA Oil Market Report states that the world oil demand is expected to reach 96.4 million barrels per day in 2021.
On the supply side, 2020 saw roughly 94.25 million barrels produced a day, highlighting how there is already a significant deficit in supply vs. demand.
Additionally, the discovery of new crude oil reserves in 2017 was the lowest since the 1940s, which is compounded by the discovery of fewer reserves each year.
Further, most members of the Organization for Petroleum Exporting Countries (OPEC), with the exception of Saudi Arabia, are nearing the end of their oil reserves.
This results in crude oil becoming more and more scarce, and as a result, more valuable with each passing day, making it a very lucrative investment.
While some demand may shift in the future with the push towards renewable energy, oil’s finite supply coupled with a vast global market is likely to drive the oil price up in future years.
How To Invest in Oil
When it comes to oil investing, there are several options available.
Here are some of the more popular methods of investing in oil:
A. Oil stocks
Oil stocks represent shares of companies involved in the extraction and production of petroleum. To maximize your earning potential, investing in a stock that pays a decent dividend yield is likely the best long-term option.
The downside of this trading energy stocks is having to perform extensive research to find the best opportunities. You should only buy oil stock in companies you’re comfortable with, and identifying these can take time.
B. Oil mutual funds
Mutual funds are a basket of stocks that you buy in one go. They offer greater diversification than investing in individual stocks and provide a less risky opportunity to enter the oil industry.
It’s important to note that there are no mutual funds that invest directly in crude oil and natural gas. Instead, you’ll gain exposure to the energy sector through several oil-related industries involved in producing and distributing energy.
C. Oil ETFs
An oil ETF (Exchange Traded Fund) is a simple and affordable way of adding oil to your portfolio. While returns may be more modest, an oil ETF takes the hassle out of making individual purchases of oil company stock while granting exposure to the oil industry.
One of the most popular oil ETFs is the United States Oil Fund (USO)
D. Oil futures
Investing in crude oil futures is more complex than trading stock or funds.
With futures trading, an investor agrees to buy a set amount of oil at an agreed price at a specific date. This allows the producer to lock in the price of what they’re selling in advance, and the buyer can lock in the price of their purchase.
No physical oil is traded in crude oil futures contracts; investors are trading the actual futures contract.
If the price of oil rises, the contract holder makes a profit when selling the oil futures contract. However, if the price falls, the holder will lose money when selling.
E. Direct participation
For a more direct oil investment, there’s direct participation (DPP).
These are investments that go directly into funding gas and oil exploration. You’re essentially purchasing a percentage of the assets held by an oil company, also referred to as working interest.
As a result, you have all the advantages of owning a part of an oil production business without incurring the costs of actually setting it up and maintaining it.
Utilizing an energy investment like DPP requires extensive due diligence and includes several unique risks, such as numerous geological and legal factors. However, DPP investments can help you benefit from tax benefits and can be a great form of generating long-term passive income.
Pros and Cons of Investing in Oil
Here are the advantages and disadvantages of investing in oil:
- Tax advantages including tax breaks on your passive income and the ability to write off your investment.
- Oil investments have the potential to generate extremely high returns.
- It’s a great option for portfolio diversification.
- Oil has the potential to generate consistent, long-term passive income.
- The crude oil price is prone to short-term fluctuations which may adversely affect your investment.
- Oil is a complicated investment to understand, involving complex legal, geographical, and operation factors.
- Significant capital investments are usually required, meaning there’s a lot of money on the line for anyone investing in it.
Fortunately, there’s an easy way to overcome some of these drawbacks.
An oil crowdfunding investment platform will take care of all the due diligence needed and will help you start investing for relatively low minimums.
Here’s a detailed look at one such platform:
The Easiest Way to Invest in Oil: EnergyFunders
EnergyFunders lets accredited investors directly invest in oil and gas drilling operations for a minimum investment of just $5,000.
Once a well is fully funded and begins operation, investors receive a share of the income generated by that well.
EnergyFunders charges zero transaction fees or assets under management (AUM) fees. The platform earns by receiving a 2% carried interest on all investments. Depending on the project, EnergyFunders will receive a 15-20% Net Profit Interest (NPI) once the investors are paid.
While returns can vary, it’s possible to see an annual rate of return topping 50%. Additionally, the tax benefit of this investment makes it appealing. As an investor, you can deduct up to 80% of your investment within the first year and write it off entirely after five years.
Additionally, the long-term nature of these investments means you have the potential to earn consistent cash flow for up to 10 or 20 years.
Investing in oil is risky and complicated, and traditionally required lots of due diligence. However, the potential for huge returns can often outweigh these negatives, especially when coupled with a crowdfunding investment platform.
If you’re interested in learning about more such alternative investments, take the MoneyMade Investor Quiz. All you need to do is answer a few simple questions and MoneyMade will suggest a list of alternative investments that suit your investing needs!