How to invest in oil

As one of the world's most heavily traded commodities, oil is an economically crucial resource that provides a large bulk of energy for the transportation and raw materials industries.¹ Investing in oil can appeal to some investors for several reasons. Oil prices often fluctuate with changes in global supply and demand, creating opportunities for potentially strong returns during favorable market conditions. Because oil tends to move differently than traditional asset classes like stocks or bonds, it can also serve as a diversification tool within a broader portfolio.

Other reasons investors might choose oil include:

• Oil and other commodities are also sometimes viewed as a potential hedge against inflation, as energy prices often rise alongside overall costs of living.²

• The oil sector’s performance is closely tied to global economic growth, so when economies expand, energy demand typically increases,³ which can benefit oil producers and related industries.

• Established companies may provide dividend income (like dividend reinvestment plans, or DRIPs), offering a stream of earnings.

• Oil represents a tangible asset, which might appeal to investors seeking exposure to real-world resources.

Investing in oil can give exposure to one of the world’s largest industries, but it’s important to understand the different investment options available to weigh the benefits and risks.

There are many different ways to invest in oil, from stocks and exchange-traded funds to futures and direct investments, each with their own risks and potential returns. In order to buy or sell oil investments, you will need a brokerage account, but it is also important to consider potential benefits and drawbacks before deciding to invest.

Here are some common ways to invest in oil.

Stocks are a method of investing in oil, giving you direct exposure to company performance and oil price movements. Investing in oil stocks typically involves buying shares of companies involved in different segments of the industry. These companies generally fall into three main categories:

• Upstream: Upstream companies generally explore and produce crude oil and natural gas from the ground.

• Midstream: Midstream companies are involved in the transportation of oil and gas, as well as operating pipelines and processing and storing raw materials.

• Downstream: Downstream oil companies are responsible for refining crude oil into finished products, as well as distributing them to the end user. This includes refineries and retailers that sell jet fuel, diesel, and gasoline.

While investing in oil stocks offers the potential for dividends and capital appreciation, which may support long-term compounding, though this is not guaranteed. They can also be highly volatile and sensitive to price swings due to geopolitical conflicts and events. You might want to do some extra research on the company you are considering investing in to further understand the potential risks and benefits.

Oil ETFs hold a basket of oil-related stocks or futures contracts, offering broader exposure without having to research individual companies. Rather than investing in a single stock, ETFs allow you to get exposure to oil investments in a more diversified manner, helping to spread potential risks. 

Mutual funds are similar to ETFs but are more actively managed. These funds tend to focus on energy industry equities. Like ETFs, they help diversify your portfolio, spreading risk, potentially protecting you against individual company challenges, but not against hits the industry may take as a whole (e.g., falling oil prices). It may be wise to look into what's included in your fund and if it fits the exposure you are looking for, as some funds and ETFs may have non-oil companies in them as well. Furthermore, while ETFs and mutual funds may spread your risk, you should still take potential losses into account.

Oil futures are financial contracts that allow traders to buy or sell a specific quantity of oil at a predetermined price on a set future date. They are commonly used by energy companies to hedge against price fluctuations, but they’re also traded by investors who want direct exposure to oil price movements without owning physical barrels.

Oil futures are typically contract based, representing an agreement to buy or sell a set number of barrels of crude oil (e.g., 1,000 barrels per contract). However, unlike regular stock trading, oil futures require a specialized brokerage account that supports commodities trading and meets specific margin requirements. Some investors may also gain indirect access to futures via ETFs that track oil futures prices. It is also important to note that due to the leverage involved in this type of investment and the volatile nature of oil, this can lead to large gains or losses. Therefore, it is crucial to understand the risk involved before choosing to invest in futures.

Investing in oil wells involves putting capital directly into oil exploration or production projects, often through partnerships or private offerings. This type of investment can be complex and is typically targeted toward investors who are comfortable with higher risk and longer time horizons.

To invest directly in oil wells, you need to be accredited, meaning you have to meet strict wealth, income, or financial sophistication standards. Some ways accredited investors may invest in oil wells include: 

• Direct working interest: Taking a portion of the drilling costs and receiving a percentage of the revenue from oil production in return. It also includes sharing operational risk and ongoing expenses.

• Royalty interest or mineral rights: Receiving a portion of revenue from whatever oil is produced on the land or rights purchased (rather than paying for drilling). This does not usually shoulder operational costs.

• Partnerships or private placements: Participation through limited partnerships (often structured as LLPs or LPs), where a managing operator runs the project and investors receive shares of profit based on their stake.

• Energy-focused private equity funds: Institutional-style funds may pool money from multiple investors to acquire interests in multiple wells or energy projects, providing diversification within the oil sector.

While direct investments in oil wells can be potentially lucrative, they require a lot of research and upfront capital and may be highly illiquid and risky.

Like other commodities (e.g., copper or energy), oil investments carry their shares of risk. Here are some potential drawbacks to watch out for:

• High market and price volatility

Oil prices can swing widely due to geopolitical events, supply disruptions, OPEC (Organization of the Petroleum Exporting Countries) decisions, or shifts in global demand. Profitability depends heavily on commodity price levels, especially for direct well investments or futures.

• Environmental and regulatory pressures

Policy changes related to emissions, drilling restrictions, or environmental compliance can increase operational costs or limit activity. Legal liabilities may arise from spills or environmental damage.

• Commodity cycle risks

Returns are tied to one sector — exposure to a single commodity means downturns in oil markets can heavily impact overall portfolio performance.

• Tax and structural complexity

Partnerships, royalties, and mineral rights investments may involve complex tax implications and distribution agreements. Revenue structures and payout timing can differ significantly depending on contract terms.

• Leverage and capital intensity

Oil exploration and production often require substantial upfront capital. Some operators use high levels of debt, which can amplify risk if prices fall.

If you are comfortable with the associated risks of such an investment, you may also consider diversifying your portfolio with lower-risk investments (such as a certificate of deposit (CD) or high-yield savings account) to help spread risks. Oil can complement, but you might not want it to dominate your portfolio.

Like with any major investment option, it is important to consider your current financial situation as well as your investment risk tolerance and time horizon to decide if oil fits into your financial goals and investment plan. Since oil prices tend to fluctuate with global demand and OPEC decisions, it might be an option for experienced medium- to long-term investors who can tolerate volatility.

Price shifts may also be influenced by geopolitical events and commodity cycles, creating an opportunity for gains but volatility for potential losses. While ETFs may offer an opportunity for beginner investors to gain exposure to the industry, they are not a risk-free investment. Understanding your risk tolerance can help you determine if oil investing is right for you.

Conservative investors, on the other hand, might prefer safer investment products like a CD. CDs let you lock your money away for a set period of time, providing predictable returns.

There are many ways to invest in oil, from company shares and energy ETFs to more complex options like futures or direct well investments. Each approach carries different levels of risk, cost, and potential return. Since oil markets are cyclical and can be affected by global events, understanding your risk tolerance and long-term financial objectives can help you decide how, or if, oil fits into your overall strategy.

If you are looking to diversify your portfolio with options that give you more predictable returns, you might want to explore certificates of deposit. Raisin can help you compare savings options that balance risk while you consider commodity-based investing.

The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.

¹ https://www.focus-economics.com/blog/top-traded-commodities/

²https://www.cmegroup.com/insights/economic-research/2022/commodities-as-an-inflation-hedge.html 

³ https://www.eia.gov/finance/markets/crudeoil/demand-nonoecd.php