Crude oil is one of the world’s most heavily traded commodities. This guide to crude oil investing will look at ways to try to benefit from rising or falling oil prices, as well as key factors to take into account when deciding whether to invest in this industry.
Crude oil prices are of great interest to many investors, as this is one of the world’s most important and most heavily traded commodities.
This guide to crude oil investing will look at the different ways that you can try to benefit from rising or falling oil prices, as well as all of the key factors to take into account when deciding whether to invest in this industry in the first place.
The huge demand for this commodity and the number of factors involved in calculating its price makes this a fairly complex investment on any level.
However, we will be looking at the subject of how to invest in oil in a way that makes it easy to understand the basics and get started if you decide to do so. To do this, you need to understand what crude oil is and why it is such a vital part of the economy.
What is crude oil?
We need to start any look at oil investing and crude oil trading by asking, ‘what is crude oil anyway?”. The answer is that this is a fossil fuel found under the Earth’s surface.
Any crude oil definition has to mention that it is a naturally occurring resource that is obtained by drilling into underground reserves.
It is then refined to obtain a range of different products, such as petroleum, gasoline and diesel fuel, which are used to provide energy in numerous ways. It also provides us with other useful products such as lubricating oils and asphalt.
The United States was the world’s top crude oil producer in 2020, with an average of 18.60 million barrels each day, followed by Saudi Arabia (10.82 million barrels), Russia (10.50 million barrels) and Canada (5.26 million barrels).
As part of the crude oil meaning and introduction, it is worth noting that the global total added up to 94.20 million daily barrels of crude oil production in 2020.
In terms of how we use this product, the US is also the leading user, importing extra barrels to increase the total used to 20.51 million oil barrels each day.
Fossil fuels account for over 60% of the energy generated in the US, while it was reported in the BP Statistical Review of World Energy 2020 that oil accounted for 33% of the planet’s total energy production.
However, their 2021 report confirms that crude oil extraction and refining has dropped significantly in the period since then. Oil consumption fell by a record 9.1 million barrels per day, bringing it down to the lowest level since 2011.
The massive level of consumption of crude oil and variety of uses for its refined products make this one of the world’s most valuable assets.
While there has been a significant increase in renewable energies such as solar power and hydroelectric energy in recent years, crude oil remains one of the most important factors in the global economy.
This means that the oil barrel price is a closely watched indicator of the economic situation and outlook.
The cost of a barrel of oil can vary widely from one day to the next and it is tracked in indices such as the Brent Crude Index and the West Texas Intermediate (WTI) which we will look at in detail further on.
“The United States was the world’s top crude oil producer in 2020, with an average of 18.60 million barrels each day.”
How does the oil industry work?
To understand how the oil industry works, we need to look closely at the three segments it can be divided into. These are known as upstream, midstream and downstream, and each plays an important part in the market.
- Upstream is the very early part of the oil and gas industry, where exploration is carried out to find new reservoirs that can be drilled. Drilling and the initial production processes are also included in this stage.
- Midstream is the part of the oil industry where the product is stored and transported from the well where the drilling was carried out to the refinery. Pipelines, tanker trucks and railways are all used as transportation methods in this phase.
- Downstream companies take on the task of refining crude oil and selling it. This means that these are the brands that are in closest contact with the public.
While drilling and exploration companies can be separate entities from those involved in the later phases, it is often the case that a large oil company will have different divisions for the upstream, midstream and downstream work.
In other cases, drilling companies and well-servicing firms contract their services to the companies who carry out the exploration and production phases of the industry.
What moves crude oil prices?
Like all commodities, the price of crude oil is largely based on the levels of supply and demand around the world. This is why investors pay close attention to the latest oil price news, to understand what is happening across the planet.
If there is too much oil entering the market or the level of demand drops for any reason, traders will feel encouraged to sell crude oil investment on the market.
On the other hand, if demand rises and the production levels remain flat or drop then traders will tend to bid crude oil higher.
Various other factors affect the price of oil. These include world events, political decisions and even rumours or speculation. A look at the eToro oil price chart shows how the price can vary widely over a relatively short period of time.
The current crude oil news is used to formulate the oil prices forecast, which predicts how the market will move in the future.
By looking at the oil price live, and using the crude oil forecast, you can see whether the price is expected to rise or fall, although other factors may come into play and render this forecast out of date before it reaches this level.
Tip: Pay close attention to world news to understand the various factors which affect the price of oil.
Oil market Investment options
Anyone who plans to invest in crude oil can choose to do this in different ways, such as choosing to buy crude oil stock, looking at ETF and so on.
In general terms, we can break down these investing options into direct and indirect methods, which are in turn made up of a few different options.
Direct investing in oil
There are various ways of investing directly in the crude oil industry, rather than simply buying stock and relying upon the oil stock price rising on your chosen company.
Derivatives markets
The majority of oil trading occurs in the derivatives markets, using the likes of crude oil futures, CFDs and options contracts.
By looking at the eToro oil page you can see the latest news and statistics concerning this market, together with the latest prices and trends.
- Oil futures contracts
Oil futures contracts are agreements where you commit to buying or selling a set amount of barrels of oil. The price and date will be agreed in advance and this means that they expire on this date unless they are rolled over.
An investor earns on this kind of contract if the actual price of oil is more favourable than stated in the contract.
- Oil drilling and service companies
Investing in oil stocks can be done by looking for shares in the likes of oil drilling and service companies.
As with any kind of stock market investment, it is a question of looking to buy at a low price and then holding onto it until the price rises enough to make a profit, or else use the dividends as income.
Buy oil shares if you want to benefit from the progress of a particular company in the sector.
- Exchange-traded funds (ETFs)
Exchange-traded funds (ETFs) also offer a direct method of investing in the oil industry. These oil ETFs are traded on stock exchanges, so you buy and sell them in the same way as shares.
With the example of the U.S. Oil Fund (USO), we can see that a single share gives you exposure to approximately one barrel of oil. A crude oil ETF can be purely on items from the oil stock market or include other commodities.
Indirect investing in oil
A different approach would see you investing indirectly in oil in any of the following ways rather than directly purchasing crude oil stock or funds.
- Energy sector ETFs
These funds include different elements of the overall energy sector, so it could include a crude oil element alongside natural gas, renewable energy companies and other parts.
- Mutual and index funds
In this case, you can opt to join mutual funds that invest in energy-related stocks, such as oil company shares.
Examples include SPDR S&P Oil & Gas Exploration & Prod (XOP), Energy Select Sector SPDR (XLE) and VanEck Vectors Oil Service ETF (OIH). Energy-specific ETFs and mutual funds that invest solely in the stock of oil-related companies come with a lower level of risk.
- Smart Portfolios
The eToro list of portfolios related to the oil industry gives you a range of options that can be used to find the exact investment you are after, while the general portfolios page gives a wider range.
If you plan to invest in a contract for difference (CFD), you can find information on the eToro CFD page, with an explanation of how fees are calculated included in the CFD section of the site too.
Oil benchmarks: Brent Oil vs. West Texas Intermediate (WTI)
You will notice that there is more than one benchmark used to track the current price of crude oil. The main benchmarks you will come across are the Brent and West Texas Intermediate (WTI).
Brent Oil
Brent oil price relates to oil drilled in the North Sea region. Over half of the world’s crude oil is priced according to the Brent oil crude price.
Brent is more widely used across the planet. One of the reasons is that it is considered a more accurate reflection of oil prices in general.
The reason for this is that it is extracted by drilling in the sea, while the American oil comes from land-based wells. This makes a difference to the USA oil price, as they need to use the less efficient method of transporting the product by railway.
The oil that is priced using the Brent benchmark is transported by sea, which is more efficient and helps to keep the costs lower.
West Texas Intermediate (WTI)
West Texas Intermediate (WTI) oil is obtained in the US. The WTI oil price benchmark is only used in North America and can be viewed by looking at a WTI oil price chart.
The WTI crude oil price tends to fluctuate less than Brent oil because it is only extracted from landlocked areas of the US.
Either of the Brent or WTI benchmarks can be used for investing purposes provided that you are clear about which one is being used.
For example, on eToro, it is the WTI index that is used, so all investments are based on WTI crude oil. This means that you will want to track the WTI oil news and the US oil price at all times.
| Brent Oil | West Texas Intermediate |
| Drilled in the North Sea region | Extracted from landlocked areas of the US |
| Transported by sea | Transported by railway |
| Benchmark used worldwide | Benchmark only used in North America |
Benefits & risks associated with investing in oil
Like all investment types, there are benefits and risks associated with investing in oil prices.
Benefits
If we start by looking at the benefits of investing in oil and gas, we can see that:
- It is widely regarded as being an attractive sector for day traders as well as long-term investors.
- This sector has a highly liquid market and can be seen as a solid way of diversifying your portfolio. This can provide an extra element of protection against inflation and any downturn in the overall economy.
- In terms of stock investment, oil and gas companies often pay regular dividends to their shareholders.
- Oil investments often provide a high level of profitability and an impressive return on investment (ROI).
- In some countries, oil industry investors also receive some tax benefits.
All of this adds up to a type of investment that is highly sought-after.
Drawbacks
If we look now at the drawbacks that you might come across when investing in crude oil, we can see that:
- The price volatility can be a concern. Stock prices in this sector are usually more volatile than in the overall market.
- This is due to them being extremely sensitive to any changes that affect the supply and demand of the commodity.
- Oil companies may also be more exposed to legal and regulatory risk factors.
- There are issues that affect their stability, such as the political risk that is present.
- The risk of a major incident, such as an oil spill, has to be taken into account. An accident of this nature can have a devastating effect on a company’s share price.
Advantages of investing in oil
Suitable for short-term and long-term investors
Highly liquid market
Possibility to get dividends
High level of profitability
Disadvantages of investing in oil
High volatility
Legal and regulatory risk factors
Risk of a major incident
General considerations about the oil market
As we have seen, this is an interesting type of investment that forces you to consider various factors.
- The high volatility is due to the way that many different factors can affect crude oil prices, although opting for the WTI index rather than Brent is one way of lowering this risk.
- You might also prefer to invest in the overall oil industry or energy sector rather than a single company.
- Since this is a major commodity that moves huge amounts of money, it offers a high amount of liquidity. This is a good sign for investors, as it means that there is less risk of being unable to sell when the time comes.
- Crude oil trading incurs fees. For example, a spot CFD is derived from a couple of upcoming futures on the commodity.
- The prices vary once the first contract expires, shifting along a curve until it reaches the price of the second contract. The overnight fee incorporates the day’s movements to provide an up-to-date price each day.
Taking all of these factors into account, oil investing is unlikely to appeal strongly to a first-time investor.
This is more suitable for an experienced, sophisticated investor who has good knowledge of the financial markets and is comfortable following the oil market news.
It is suited to someone who is looking for an interesting, potentially rewarding way of diversifying their portfolio.
Conclusion
Investing in crude oil or other energy markets is an interesting option that appeals to a lot of people.
In this article, we have seen that it is a diverse market where you can choose to invest in any one of several ways. You can buy oil shares, invest in ETFs or look at the other varied methods we have examined here
Trading in crude oil is something that requires some time and knowledge, as you need to understand what factors move the market and the long-term price history of the commodity, as well as the prevailing crowd behaviour that leads to price swings.
In addition, knowing about the different types of investment and the differences between the two commonly used benchmarks are other vital pieces of information that will allow you to make good decisions.
By understanding the issues, we have looked at here, you can make an informed decision on whether crude oil trading is right for you.
FAQs
Why does the price of crude oil vary?
Are there other oil benchmarks than Brent Oil and WTI?
How can I invest in oil?
This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments. This material has been prepared without regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past performance of a financial instrument, index or a packaged investment product are not, and should not be taken as a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.