The oil and gas industry is one of the most important sectors in today’s global economy. It is also one of the most volatile. The past few years have been particularly challenging for this sector, with a perfect storm of falling prices, overproduction, and weak demand wreaking havoc on producers and their investors. However, there are also several opportunities for savvy investors willing to take the risks involved with backing this dynamic industry. In this article, we take a closer look at the state of the oil and gas industry today, its key players, as well as some promising investment opportunities for those interested in getting involved.
What’s making the oil and gas industry so volatile?
Oil and gas prices have been in a free fall since 2014, with Brent crude, the global benchmark, trading at $26 a barrel in February 2016. This is a far cry from the $110 per barrel price in June 2014, which was the highest since the 2008 Financial Crisis. Many factors may have contributed to the volatility in the oil and gas prices, including overproduction, weak global demand, and a strengthening U.S. dollar. What’s more, there has been a slowdown in non-OPEC production, and OPEC has tried to stabilize prices by reducing production. This also contributed to the increased volatility.
Investing in Oil: Where to begin?
Oil and gas companies producing crude oil or natural gas are required to have an equity investment of at least 50% based on the country of operation. As such, they are also subject to the country's legal and regulatory framework. Investors who are willing to take the plunge into the oil and gas sector will likely find it worth their while to start by looking into this requirement. These types of investments are considered long-term plays and those considering adding oil and gas stocks to their portfolio should keep the following factors in mind:
- Volatility - Due to the cyclical nature of the oil and gas industry, prices for crude oil and natural gas can be highly volatile. This means that oil and gas stocks are seen as high-risk investments that are best suited for investors with a long-term investment horizon.
- Risk - Investing in oil and gas companies is not without risk. The sector is known for being one of the riskiest in the stock market. This is due in part to the sector’s cyclical nature, as well as the fact that many of the companies operating in the sector are hugely leveraged.
- Access - There is a wide range of investment options in the oil and gas sector. Investors can choose between investing in upstream and downstream producers, as well as service providers.
An Introduction to Oil Commodities
Oil commodities are a group of physical commodities used in the production of oil and gas. They include crude oil, natural gas liquids, refinery feedstock, and diesel and gasoline blending components. Traditionally, crude oil has been the most significant of these commodities and has accounted for the majority of the global energy demand. Crude oil is a globally traded commodity that is traded on many exchanges, including New York Mercantile Exchange (NYMEX) and Intercontinental Exchange (ICE).
Other Commodity Investments in the Oil Industry
Commodity investments are all about finding commodities that have a low correlation with crude oil, such that they won’t move in tandem with this commodity. This will diversify a portfolio and reduce the risk of losses. Some of the most popular commodity investments in the oil industry include natural gas, natural gas liquids (NGLs), Brent crude, and gasoline. Natural gas prices are closely tied to the weather, as mild winters generally result in increased demand for this commodity. Brent crude is a major benchmark crude that is traded on NYMEX. Gasoline is the main distillate used in automobiles, and it is also a significant feedstock in the production of petrochemicals. NGLs are used to make ethylene feedstock, which is used to make plastic and polyester.
Equity Investments in Oil Companies
One of the most popular investments in the oil industry is in the equities of oil companies. Oil companies are primarily engaged in the exploration, production, refining, and marketing of crude oil and natural gas. Many of them are vertically integrated and have a broad portfolio of assets and expertise in various segments of the energy industry. Investors can choose from over 30 oil exploration and production companies from across the globe. The size and complexity of these companies vary significantly, so investors should carefully select the most appropriate company based on their risk tolerance and investment objectives. Oil exploration and production companies have been under significant pressure in recent years as the price of crude oil has plummeted, making them some of the riskiest investments in the energy industry.
The Bottom Line
Investing in oil and gas companies is a challenging undertaking, and investors must select the right companies at the right price. However, there are a variety of ways to get involved in this sector, all of which have the potential to yield significant rewards over the long term. As always, investors should keep their eye on the ball and exercise due diligence when selecting companies to invest in, as this will go a long way toward reducing the associated risks.
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