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The world consumes almost 87 million barrels of petroleum per day — that's certainly a lot. Crude oil is one of the most traded commodities in the world.
Investors and traders are trying to get exposure to “black gold” by owning physical commodities, oil futures, shares of energy companies, crude oil exchange-traded funds (ETFs), oil mutual funds and master limited partnerships (MLPs).
Oil as a Physical Commodity
Unlike gold, silver, or other natural resources, it is very hard for a retail investor to own physical crude oil because it is highly toxic, volatile and as such, it is difficult to store.
You would require a very sophisticated logistics to move and store oil, so it is not cheap to own or rent this type of infrastructure. To avoid the high cost and logistical nightmares, it is better to try to get exposure to crude oil through other forms.
Option 1: Oil Futures
A purchase of an oil futures contract obliges you to buy crude oil at a specified date in the future. Most of the brokers don’t allow a physical delivery of the commodity. Instead, they insist on a cash settlement.
This means that if you buy 1 oil futures contract at $65 and it drops to $64 at the expiration date, you would lose $1 per barrel. Because a standard quantity for a futures contract is 1,000 barrels, your loss would be $1,000. But you don’t have to wait for the expiry.
At any time you can decide to sell the futures contract you bought and lock the profit or loss. To buy oil futures you need to deposit an initial margin, which can vary depending on crude oil prices, but it is around $3,800 per contract. One contract gives you an exposure to $65,000 ($65 x 1,000 barrels) worth of oil, which is pretty high leverage.
Since crude oil price is volatile, you have to be very careful trading futures contracts.
Option 2: Crude Oil ETFs
With futures contracts, you have to pay attention to the maintenance margin. If the price drops after you purchase a futures contract, your loss is going to be deducted from your account. And if your account drops below maintenance margin you are going to receive a margin call, which is a call from your broker asking you to deposit more money into the account.
If you don’t want to deal with that, you can buy shares of an ETF, which owns crude oil futures and tries to replicate the price movement of crude oil. This might not always be the case as these funds usually own a basket of crude oil futures contracts with a different expiration, whose price change can differ from the price change of the front-month contract, a contract usually considered as the benchmark for the price of crude oil. United States Oil Fund LP (ETF) (NYSE: USO) is one of the available funds.
Option 3: Energy Stocks
The price of energy stocks doesn’t move exactly the same as crude oil prices, but the business of these companies is directly affected by the changes in crude oil and so is the price of their stocks.
The energy stocks usually pay a high dividend yield so they are often interesting for dividend investors. Exxon Mobil Corporation (NYSE: XOM) is an example of a company that could give you exposure to crude oil.
If you don’t like stock picking you can buy an ETF, like Energy Select Sector SPDR ETF (NYSE: XLE) that owns the energy companies. Some of its holdings include Exxon, Chevron (NYSE: CVX) and Schlumberger Limited (NYSE: SLB).
Option 4: Oil Mutual Funds
One way to get exposure to the energy companies is by investing in an energy-focused mutual fund. Holdings of energy mutual funds can be pretty similar to the holdings of ETFs but with different weights.
Fidelity Select Energy Portfolio, Vanguard Energy Fund and T. Rowe Price New Era Fund are examples of energy mutual funds.
Option 5: Master Limited Partnerships
MLPs are publicly-traded limited partnerships and became interesting to investors because of their tax benefits — they are not taxed at a corporate level. Investors who purchase shares of MLPs are limited partners and they receive distributions from the MLP.
There are also general partners who manage daily operations and receive compensation based on the MLP’s performance. Magellan Midstream Partners, L.P. (NYSE: MMP), Energy Transfer Partners LP (NYSE: ETP) and Buckeye Partners, L.P. (NYSE: BPL) are examples of midstream MLPs. They operate storage and transportation assets.
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You don't have to be an oil tycoon to benefit from the most widely-traded commodity in the world. It can be as simple as opening a brokerage account and choosing the investments that are right for you, whether they are mutual funds, ETFs, Master Limited Partnerships, ETFs, futures, or commodities.