Oil prices are in the news every day, and some of the world's biggest companies do nothing but find it, drill it out of the ground, and sell it. Oil is called "black gold" for a reason: every one needs it, whether it's for a car, to run a factory, or to heat a home. Now that you've decided to invest in the oil market, you need to know where to get started and how to avoid poor bets that could leave you covered in financial grime.
Energy Stocks and Funds
Buying the stock of energy companies is probably the easiest way to invest in the oil market. The stocks usually rise along with the price of oil, and most of these investments also pay dividends. That means you get a nice, steady stream of income in addition to any profit from the rise in the stock. If the idea of stock investing gives you a case of the financial-novice willies, you can always buy energy mutual funds. You pay for shares of the funds, which hold a long list of investments in oil drilling, refining, marketing, and oilfield services. A professional manager makes the investment decisions and takes a fee out of the fund. Energy funds spread your risk around and make the entire investment process easier.
If you want more control, but don't want to risk your money on single companies or pay fund fees, research some ETFs. These funds put their money into a single sector, such as currencies, gold, and the ever-popular "oil and gas." ETFs in the energy sector buy and sell oil futures contracts as well as energy stocks, preferred shares, and the speculator's favorite: options. (ETNs are exchange-traded notes, which invest in bonds and other debt instruments.) When the oil price goes up, the ETF shares rise even faster. They trade on the stock market like stock shares, with a price determined by the market's supply and demand. They're more volatile than mutual funds and riskier, but they don't charge fees and they also can get you a bigger profit. There are a couple of dozen energy ETFs, including ProShares Ultra Oil & Gas Fund (ticker symbol DIG) and Oil Services HOLDRS (ticker symbol OIH).
If you want to take on a little more risk, look at futures. These are contracts to buy commodities, such as crude oil; you can buy or short (sell) them. Oil futures represent an investment in 1,000 barrels of oil. They carry settlement dates, and their price gyrates with the market spot price for oil and other information, such as supply and inventory data provided by the United States Energy Information Administration (EIA). For speculators, futures involve a lot of leverage and risk (brokers allow traders to put up as little as 5 percent of the contract face value). You can make a major killing if you guess right on the oil price, but a position that goes the wrong way can blow up your account and stick you with a big loss.
A direct capital investment in an oil-drilling operation has tempted many investors seeking to strike it rich in a legendary business. Theoretically, your money goes directly into a producing or exploratory well, with a potential return many times greater than an indirect investment in stocks, mutual funds or futures. The tax authorities allow you to partially write off your investment, which can potentially reduce any taxes on your income. However, oil wells are a largely unregulated investment field chock-full of scam artists and frauds. Before venturing into any direct investment in oil production, do your own research and show the prospectus to a broker, attorney or accountant you know and trust.
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