Oil stocks: Understanding the basics of investing in oil
Oil has been one of the top-performing asset classes in 2021, but before jumping in, here’s a reminder of the basics of oil investing…
Oil is cyclical: This means oil prices tend to rise when the economy is doing well and fall when it isn’t.
- Like most things? Yes, but cyclical stocks tend to move further in either direction as the economy changes.
- In oil’s case, prices tend to swing in a pendulum over time — as opposed to trending in one direction.
Key drivers: Fundamentally, oil stocks rise and fall as oil prices move. But in reality, their relationship is much more complicated.
- The two are heavily correlated but a 5% increase in oil prices doesn’t necessarily mean a 5% increase in oil stocks.
- Some companies are better positioned to benefit from a rise in oil prices — i.e. lower operating costs, less debt, capabilities to ramp up production when oil prices are high, etc.
Don’t walk in blind without considering these factors when investing in oil. Instead, try your chances with an oil ETF like the Energy Select Sector SPDR Fund (NYSE:XLE).
Also this: Oil companies require a lot of capital. Once an oil well runs dry — companies must invest in new production in a never-ending treadmill.
- This puts many oil companies in heavy debt levels — which grew as oil prices fell from their $100+ levels in 2014.
- In the past few years, US oil companies prioritized increasing production over profits — leading to poor investor returns.
On top of these problems, the oil industry is dealing with the threat of electric vehicles taking over.
Investors: Don’t take your eyes off your oil investments. The upward trend is anything but certain and several factors could quickly send prices back down.