Investing in Oil: A Risky Yet Lucrative Market

Gold and oil are investments that can never go wrong in the long run. The demand for oil is only growing, not reducing. As the world sees a host of countries in Asia ramping up growth, there is going to be a greater demand for oil. The growth forecast for America is positive for 2012. America gets most of its oil from Nigeria. Domestic problems in Nigeria have however led to lower supply and higher prices. Oil prices are expected to touch $100 soon. This is also in the backdrop of diminishing supply of oil from Mexico and Brazil. Countries like Syria, Chad, Iraq, Pakistan and Algeria are facing civil unrest or war like conditions.

According to the oil market report (http://omrpublic.iea.org/tablessearch.asp), North America is expected to need 23.4 million barrels per day in 2012. Forecasts for Europe, China and rest of Asia stand at 14.1, 10 and 11 million barrels per day.

On the supply side expected production from North America, Europe, China and rest of Asia stand at 14.7, 3.9, 4.3 and 3.5 million barrels per day for 2012. Total Demand for 2012 globally is 90.3 barrels per day and supply is 49.5 million barrels per day. Throw in high uncertainty from Iran, growing demand from emerging economies and the share of global biofuels at about 1.9 million barrels per day in 2012 and you will understand why oil is a good commodity to invest in, not just pay for.

Many countries subsidize the oil they purchase. This leads to higher consumption, but lower fuel efficiency. The oil companies in these countries run under great losses. Many countries like Indonesia, Malaysia, India etc. have tried to reduce subsidies, thereby increasing inflationary pressure on the general public. However, public pressure has led to roll backs in many countries.

As you can see fluctuations in oil makes it ideal for investing. The most obvious way is to trade in stocks of oil and oil exploration companies. One can also invest in sector funds. An example of an oil and gas based mutual fund in 2011 is Icon which manages assets worth $620 million. It has in its portfolio Chevron, Mobil, Exxon, Conoco and Schlumberg. Fidelity Select Energy which manages about $2.37 billion also has Exxon Mobil, Chevron, Schlumberg, Occidental and Transocean in its fund. (Source: www.investorplace.com).

Yet another way of investing in oil is through exchange traded funds (ETFs). Oil ETFs are a bouquet of oil future contracts and oil stocks or oil indices that track the price of oil. This is a lot less cumbersome than investing in individual stocks or indices. Oil ETFs like all ETFs attract lesser fees and capital gains tax are incurred post fund sale.

Oil futures are an option for investment in the energy sector. Many oil ETFs are sold close to expiry date. This sometimes leads to Contango where the spot prices are lower than its future price. Conversely backwardation can occur in futures, where future prices are lesser than spot. Futures and ETFs are affected by contango and backwardation.

Also in the market is the oil exchange traded notes or ETNs. They are devoid of tracking risk, since they are in effect pre-paid contracts. They do however have issuer risk. ETNs are unsecured debt notes by an underwriting bank. Payments on ETNs are linked to the performance of the index. ETNs are liquid and can be traded on the market floor like securities. Barclay’s iPath is an example of an oil ETN.

The ground rules for investing in oil as they are in any other sector only more intricate. This is an extremely volatile sector, whose demand is affected by wars, tornadoes and floods. The growing markets of Asia and Latin America will continue to keep oil demand on a high. In the long term, investing on oil is profitable. In the short term too, investing in oil, particularly now being the peak period is expected to yield gains.