Knowing the ins and outs of how to invest in oil stocks will help you cut your risk—and boost your gains.
Here are 6 tips to always keep in mind when you are investing in oil stocks:
1. Look for oil and gas exploration companies that have cash flow from existing wells that is sufficient for, or at least contributes to, the development costs of additional wells.
Junior energy stocks are risky to invest in, because it’s relatively cheap and easy to launch a penny oil or other energy stock and sell stock to the public.
Invest in oil and gas energy stocks that own diversified drilling sites in multiple geographic locations where exploration has been successful in the past.
Stay away from junior energy stocks operating in insecure and politically unstable regions, or in countries with little respect for property rights and the rule of law. Resource extraction is inherently a politically vulnerable business; you can’t move the oil wells to another country, and local citizens sometimes believe that a foreign resource company is robbing them of their birthright, even though they need the foreign company’s capital and expertise to get any value out of the ground.
Look at the market cap of oil and gas exploration companies versus the estimated value of the reserves they have in the ground. Sometimes, a company’s marketing efforts are so successful that they drive the stock up too high in relation to the size of their findings.
Invest in oil and gas energy stocks that use innovative new drilling and exploration techniques. Staying ahead of the curve will keep them in business.
The real story on mining stocks
Mining stocks play a key role in your portfolio whatever commodity prices are doing. Pat McKeough tells you why in this special report—and gives you the outlook on gold, copper, uranium, and the remarkable story of Canadian diamonds.
New technology plays a part in knowing how to invest in oil stocks
Oil is a key factor in a lot of industrial activity, as a raw material or as fuel for transportation. When oil prices shoot up, producers gain, but the economy suffers. This, though, has changed lately due to the development of vast oil and gas production from shale and other so-called “tight rock” formations.
The improving technology of the past decade has opened up vast new potential oil sources. In the past, much of the world’s oil came from big underground pools, mainly concentrated in isolated areas such as the Mideast, where corrupt, volatile and backward governments were common.
The new technology produces oil from shale, a form of rock. Oil-bearing shale deposits are common and widely spread out around the world.
The new technology faces political and economic obstacles. Costs, however, are likely to fall as the new technology develops. It’s just a matter of time before oil production from shale becomes common all around the world. With oil production spread out rather than concentrated, oil prices will generally be lower and less volatile. So the inevitable recovery from the recent oil price plunge may turn out to be weaker and slower than past oil-price recoveries.
The key to how to invest in oil stocks is related to commodity pricing
Commodity prices are subject to wide and unpredictable swings. In the rising phase of the business cycle, when business is booming, resource demand expands faster than resource supply, so resource prices shoot up. This balloons profits for commodity investments. When the economy slumps, resource prices and commodity prices fall, and this drags down resource stock prices.
A crucial rule for commodity investing: if people generally believe the price of a commodity is sure to go up, the reverse often happens because both suppliers and users of the commodity also read the newspapers. They both take steps to protect themselves and profit from the situation. The suppliers try to increase supplies, and the users try to become more efficient or find alternative commodities.
Advice on investing in oil
Our advice is for most investors to maintain some exposure to the oil industry as part of the Resources segment of your portfolio. Overall, though, now is a particularly good time to stick to our three-part Successful Investor approach: Invest mainly in well-established, mainly dividend-paying stocks; spread your money out across most if not all of the five main economic sectors; downplay or avoid stocks in the broker/media limelight.
Put perhaps half the money you intend to invest in the Resources sector into oil and gas stocks. But only buy these or any stocks if you are prepared to hold them for at least a while.
Above all, when considering how to invest in oil stocks, resist the urge to go overboard, particularly in high-risk oil investments such as junior oils, futures, options and so on. They are as risky as ever, and they may especially fail to thrive in a slow oil recovery.
Did this information help you understand how to invest in oil stocks more thoughtfully? Are you already investing in oil stocks? Share your story with us in the comments.
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