Crude oil stocks: Are they a good type of investment?

Investment in oil stocks can be highly profitable if you get the basics right and follow crude oil prices closely.

It is fair to say that the world runs on crude oil and its derivatives. As a result, these products are heavily bought and sold globally every day. Between the oil-producing countries and the global demand, the demand-and-supply dynamics influence crude oil price daily.

As an investment, crude oil and oil stocks add a different dimension to one’s investment portfolio. Of all the popularly traded items in the commodity market (precious metal, base metal, agricultural products etc.) crude oil is unique for its importance as an import, and hence its price movements. Most crude oil stocks are known for their oil price sensitivity.

Why invest in oil stocks?

• High profitability: Oil stocks have traditionally posted good profits, despite demand slowdowns that make prices plummet. However, once oil is explored, the cost of drilling, transporting, refining, storing, and distributing are all fixed costs. If oil prices remain above these costs, the profitability of oil companies is guaranteed.
• Different industry segments: Within the oil industry, you can choose the types of stocks you are most comfortable with. It includes stocks of upstream or exploration companies that are sensitive to oil price fluctuations. Midstream companies run on fixed rates and contracts, so they are significantly insulated from volatility. Downstream companies refine and market products, and have a fixed income portion on the refining part. They are affected by oil prices, but to a lesser extent.  
• Demand: The supply and demand for oil products are never under any doubt, except for temporary lulls. As long as dependency on fossil fuels remain, countries can be expected to continue to buy oil. 

Related: Understand the risk associated with mid-cap stocks

What are the risks involved in investing in crude oil stocks?

• Price volatility: Oil price fluctuates as a reaction to a variety of factors. Investors may find it difficult to spot the changes in business cycles and macroeconomic factors that affect oil prices.
• Sunk cost: Oil exploration is like a shot in the dark, although technology is helping oil companies with useful insights. Nevertheless, hitting a dry hole at the end of a capital-intensive exploration can lead to losses that would reflect in the stock price. 

Related: Are subsidies good or bad for India?

Tips for investing in crude oil stocks 

Once you learn how to buy crude oil stock, you have to pay attention to the factors that can cause oil price fluctuation. Production challenges can affect oil prices, as can an oil demand standstill like the one during the pandemic. A look at the price-to-book ratio will reveal if an oil stock is undervalued or overvalued. 

You should also monitor industry developments (such as mergers) to aid your investment decisions. As explained earlier, the risk exposure varies between different types of oil companies. Therefore, it is important to diversify your investment among different types of oil companies. Futures trade is also used by oil stock investors to mitigate risk.

Crude oil and oil-related stocks can be hugely profitable and be a welcome diversification of your investment portfolio. By investing in oil stocks while prices are bottoming, you can reap the benefits of price rebounds. Understand what are stock SIPs.

Disclaimer: This article is intended for general information purposes only and should not be construed as investment or legal advice. You should separately obtain independent advice when making decisions in these areas.