Oil futures are a thrilling asset to trade, but don’t be fooled by their allure; they’re not for everyone. Before you go in, make sure you’re aware of the risks involved with trading these assets:
One Contract Represents 1,000 Barrels of Oil
With 1,000 barrels of crude represented by one contract, a $0.50 drop in the price of a barrel of oil equals a $500 loss for the investor. At the same time, any market built around a high-demand commodity like oil is prone to volatility.
The combination of high volatility and minor price swings means large gains or massive losses, which is a dangerous proposition.
Leverage
The majority of oil futures traders use margins, paying significantly less in actual cash than the value of the oil futures they’re buying. While the enhanced potential rewards associated with borrowing money to invest are appealing, the possible drawback is a bitter pill to chew.
The losses on these investments can be exactly as severe as the gains, implying that unpleasant losses might occur quickly.
Futures Expire
You own a share of stock until you decide to sell it, and it has some worth regardless of whether the stock price is higher or lower than when you bought it.
If you don’t sell or execute a futures contract before it expires, on the other hand, you’ll be left with a worthless piece of paper.
Unknown Supplies
Oil has a finite quantity on Earth, but the extent to which it is constrained is uncertain.
There are a plethora of oil exploration businesses devoted to discovering previously undisclosed reserves of oil hidden deep beneath the Earth’s crust, and every now and then, you’ll hear of a successful discovery. Large finds are usually accompanied by concerns about increased supply, which can cause the price of oil to drop.
Going Green
There is an increasing demand for energy as the world’s population grows, but this does not indicate that the energy must be given by burning fossil fuels.
Some oil investors believe that green energy will never be able to completely replace the demand for crude oil, and they may be correct. However, in ten years’ time, the amount of oil required to power the planet may be significantly reduced.
Every time you hear about the next generation of electric vehicle, solar panel, or hydrogen fuel cell, you’re hearing about technology that has the potential to reduce crude oil demand significantly.
Is now a good time to invest in oil?
You could think that oil production and demand peaked a long time ago if you read the headlines in most newspapers, especially with the rise of solar, wind, biodiesel, and other green alternatives. The influential “Club of Rome” coalition of businessmen, scientists, economists, and government officials propagated the concept of “peak oil,” which proved out to be completely incorrect.
The Limits to Expansion was published in 1972, and it was an extremely negative analysis based on an MIT computer simulation of economic and population growth, as well as scarce resources. According to the estimate, all known petroleum reserves would be depleted by the end of the century if consumption levels remained constant. Gas and petroleum would be extinct by 1982 if consumption rates continued to rise.
What happened was that we improved our ability to locate and extract oil and gas! This was owing to advancements in technology as well as fresh discoveries. We now produce 28 percent more oil in the United States than we did at the previously acknowledged “peak oil production” era of 1970. Today, the United States leads the world in oil production, significantly outperforming Saudi Arabia, which is in second place.
Myth #2: Alternative energy is where all the opportunity is!
The truth is that global energy demand is continually increasing, and this demand is being satisfied by both alternative energy and oil and gas expansion. We anticipate that energy will be a “both/and” game for years to come, rather than a “either/or” issue.
Alternative energy is a burgeoning business with a lot of room for expansion. For environmental grounds, it is convincing. It also comes with a lot of danger and expense, some of which has been borne by taxpayers.
Some green energy technologies have proven to be successful. Solar and wind energy are becoming more affordable. Solar energy has proven to be so efficient that solar energy storage has become a profitable industry. Electric vehicles are becoming increasingly popular and attractive, which leads to the next urban legend:
Myth #3: Electric vehicles have decreased the demand for gasoline.
While energy supplies are diversifying in the United States and around the world, which is a positive trend, demand for oil and gas has not diminished. Oil consumption continues to rise, particularly in China and India, as well as in the United States. Since 2006, demand for oil has consistently climbed, as shown in the graph below.
Despite the rise of electric vehicles, demand for all types of energy has only increased as a result of population growth and changing lifestyles. Even as more people purchase electric vehicles, there will always be a demand for oil due to the use of plastics (which are manufactured from petroleum) and the use of diesel in trucks and heavy equipment. (The eia.gov chart below does not include the most recent quarter.)
Myth #4 Oil companies and investors can’t make money at $35 an barrel!
Companies in Texas, for example, are profitable even at $18 per barrel. However, for the shale business to be successful, higher barrel prices are required. We do not advise you to invest in shale companies. Even at current barrel pricing, however, there is a big potential!
Wouldn’t the stock market be the best way to have exposure to oil and gas?
Most likely not. Investments receive large tax benefits in order to encourage the country toward energy independence. This means that drilling costs, from equipment to labor, are tax deductible up to 100% in the oil and gas industry. Oil and gas investments are a great way to offset income or gains from other sources. For many people, this makes oil an excellent investment!
Oil and gas can be purchased in a variety of ways, but stocks are not one of them. Let’s take a look at three possibilities and some of the benefits and drawbacks of each:
Stocks and Mutual Funds
ETFs, mutual funds, and large and small-cap equities are all examples of this. Because most gains are re-invested, stocks offer limited upside for shareholders. Oil spills and other unfavorable headlines can have a severe impact on large corporations and their stock prices.
On the plus side, an oil-and-gas mutual fund or exchange-traded fund (ETF) provides some risk protection through company diversification. If you don’t have a large chunk of money to invest, the stock market can be your only alternative.
Unfortunately, shareholders will miss out on one of the most significant advantages of investing directly: tax deductions!
Equity Direct Participation Programs
The most profitable approach for most investors to participate in oil and gas is through an equity investment or a Direct Participation Project (DPP). A DPP is a non-traded pooled investment that works over several years and provides investors with access to the cash flow and tax benefits of an energy business. (Real estate DPPs, like oil and gas DPPs, operate in a similar manner and, like oil and gas DPPs, can engage in 1031 tax exchanges.)
A DPP is primarily used to fund the development of numerous wells in the oil and gas industry. The benefit to the investor in the first year is the tax write-off, which can be up to 85% of the investment. When the drilling is finished after about a year, investors begin to receive a monthly dividend. Depending on the success of the drilling, the returns can range from very low to very high. The first 15% of this income is tax-free, while the rest is regarded as ordinary income. (Consult a tax advisor.)
The well bundle is normally sold to a larger oil company after around 5 years. The proceeds from the sale are subsequently allocated proportionately among the investors, and the profits are taxed as capital gains.
Asset class diversification, great profit potential, and large tax advantages are all advantages of direct investments in oil and gas. Multi-well packages and skilled operators can help to limit risk to some extent. Investors, on the other hand, must be mindful of the drawbacks. Oil and gas ventures are inherently illiquid and speculative. Returns can be substantial, but they can also be non-existent. Oil prices have an impact on profitability. Furthermore, accredited investors are the only ones who can invest in DPPs.
Mineral Rights Leases
This is not an oil and gas investment, but rather a private financial agreement that works similarly to a real estate bridge loan. Investors are paid monthly cash flow based on contractually agreed-upon returns. The average investment time span is one to three years. Mineral rights leases demand lump sum payments to participate.
In this podcast with Kim Butler, “Investing in Mining Rights,” you’ll learn more about mineral rights leases.
Is Oil a Good Investment for You?
Do you have oil and gas in your portfolio? Direct investments in energy projects can provide significant and almost immediate tax benefits, as well as diversify investments and potentially increase returns. Oil and gas investments are worth considering as part of your overall plan because of these advantages.
For some, oil and gas may be a smart investment, but for others, it is not. There are requirements to be met, risks to be handled, and decisions to be made. The best investments in this field are only available to accredited investors. Some investors choose to put their money into greener options, while others are drawn to the oil and gas industry’s proven track record of earnings.
You might have other concerns about investing in oil and gas. We most likely know the answers! Partners for Prosperity focuses on wealth accumulation outside of the stock market. To learn more about hedging risk, boosting cash flow, and producing wealth that is not reliant on Wall Street dangers, schedule a complimentary appointment now!
Is it possible to buy oil futures?
There are a few different ways to get your hands on crude oil futures. The following are a few of the most common:
- Directly purchase oil futures. The first alternative is to buy and sell oil futures on a commodities exchange directly. The New York Mercantile Exchange (NYMEX) and the Chicago Mercantile Exchange are two of the most well-known (CME or CME Group). You can also use a broker, such as TradeStation, to make your transaction.
- ETFs can be bought and sold. You can invest in oil-related exchange-traded funds if you’d prefer let someone else handle the buying and selling of oil futures while paying minimum costs (ETFs). However, before you acquire a fund, make sure you read the fine print. Some of these funds invest in oil futures and other oil-related derivatives, while others invest in oil producing firms, so you won’t have any direct exposure to physical oil.
There are a few things to bear in mind regardless of how you choose to get into the futures industry:
- Price fluctuations are frequent. Oil futures prices are notorious for their extreme volatility. As a result, it’s critical that you stick to your trading plan, even if that means occasionally accepting a loss – an unpleasant truth that all investors must embrace.
- It’s essential to conduct research on a daily basis. The price of oil is affected by a number of factors, each of which can produce significant price changes on its own. Not only should you conduct daily research, but you should also keep up with the news, not only to keep track of how oil is performing at the present, but also to keep track of the state of geopolitical and economic situations, weather events, and the other elements stated above.
- If you don’t know what you’re doing, don’t use margins. The attraction of the enormous rewards that successful margin trades can give is difficult to ignore as a newbie. You should avoid trading on margin until you are an experienced oil futures trader, no matter how challenging it may be. Sure, there’s the possibility for massive returns, but there’s also the risk of large loses.
Will oil prices continue to grow or fall?
Brent crude oil prices are expected to average $82.87 per barrel in 2022, according to the EIA. WTI is expected to average $79.35 per barrel in 2022, up from $68.21 per barrel in 2021. Oil prices are rising due to a drop in supply and a rise in demand.
Will there be a recovery for oil?
According to the EIA, oil output in the United States is predicted to average 11.9 million barrels per day in 2022. In 2022, global oil consumption is predicted to rebound to 99.5 million barrels per day, around the same level as in 2019.
What impact do oil futures have on oil prices?
Oil futures, also known as futures contracts, are agreements to buy or sell oil at a certain price at a specific date in the future. Traders in oil futures make bids on the price of oil based on their expectations for future prices. To decide the price, they look at predicted supply and demand. Traders will raise the price of oil if they believe demand will rise as the global economy expands. Even when there is ample supply, this might result in high oil prices.
What is the procedure for purchasing oil futures?
Oil futures are agreements to exchange a specific amount of oil at a specific price on a specific date. They’re traded on exchanges and reflect distinct forms of oil demand. Oil futures are a popular way to purchase and sell oil since they allow you to trade increasing and decreasing prices.
What is the value of an oil futures contract?
Crude oil futures contracts have a 0.01 per barrel specification and are worth $10.00 per contract. Sunday through Friday, electronic trading of crude oil futures is performed on the CME Globex trading platform from 6:00 p.m. U.S. to 5:00 p.m. U.S. ET.
How do I go about purchasing a barrel of oil stock?
You can invest in oil commodities in a variety of ways. Oil can also be purchased by the barrel.
Crude oil is traded as light sweet crude oil futures contracts on the New York Mercantile Exchange and other commodities markets across the world. Futures contracts are agreements to provide a specific quantity of a commodity at a specific price and on a specific date in the future.
Oil options are a different way to purchase oil. The buyer or seller of options contracts has the option to swap oil at a later period. You’ll need to trade futures or options on oil on a commodities market if you want to acquire them directly.
The most frequent approach for the average person to invest in oil is to purchase oil ETF shares.
Finally, indirectly investing in oil through the ownership of several oil firms is an option.