Investing in oil stocks and other resource sector investments can be profitable if you choose technologically advanced, well-run companies

We continue to advise against overindulging in oil stocks. That’s because the Resource sector (including oil) is highly volatile, and no one can accurately predict future oil prices.

However, you can profit over long periods by reasonably investing in oil stocks. Most investors can hold a portion of their portfolios in well-established and well-managed Canadian oil stocks, especially those with high-quality reserves and rising production. These companies are well-positioned to profit during periods of high oil prices, and are able to at least partly offset price declines by producing more oil.

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Three steps for limiting risk when you’re investing in oil stocks

1. Look at the market cap of oil and gas 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.
2. Invest in oil and other energy stocks that own diversified drilling sites in multiple geographic locations where exploration has been successful in the past.
3. Buy oil stocks that use innovative new drilling and exploration techniques. Staying ahead of the curve will keep them in business.

Investing in oil stocks: Fracking has revolutionized the oil and gas industry

Shale development boosts oil production as well as natural gas output. This depresses the profit margins of current oil and gas producers, but in some ways that’s a good thing for the overall economy and consumers.

Of course, environmental opposition could eventually slow the prominence of shale oil and gas production at least in some regions. The shale industry, like any new industry, needs to continue to develop environmentally safe operating procedures.

The most controversial procedure is the hydraulic fracturing, or fracking, of hydrocarbon-bearing shale. This process involves pumping a mix of water, chemicals and other materials into shale rock formations that contain oil or natural gas. This fractures the rock and releases the oil and gas. Some environmentalists are worried that fracking chemicals will leak into drinking-water supplies.

But governments have to weigh environmental opposition against the vast increase in jobs and tax collection that shale development brings.

Our advice for investing in oil stocks and other investments in the Resources sector

Our advice is for most investors to maintain some exposure to the oil industry as part of the Resources segment of your portfolio.

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.

Bonus Tip: Investing in ethanol stocks

Ethanol is a liquid alcohol obtained from fermenting sugar, or starch converted to sugar. In Canada and the U.S., fuel ethanol is made from corn, as well as grains such as wheat and barley.

Relative to gasoline, ethanol fuels reduce greenhouse gas emissions. As well, ethanol is made from plants, which absorb carbon dioxide during their growth. On a full-fuel cycle (i.e., from plant growth to use of the fuel in a vehicle), a 10% ethanol-gasoline blend is estimated to reduce greenhouse gas emissions by up to 4% if the ethanol is made from grains and up to 8% if it is made from cellulosic biomass.

Ethanol as fuel, and ethanol stocks as an investment, have a lot of conceptual appeal, especially with investor interest rising for non-hydrocarbon (oil, coal, natural gas), lower-polluting energy sources such as wind and solar. However, many ethanol stocks have difficulty showing profits. Several new ethanol plants will open in the next few years, which could lead to oversupply and lower prices. Lower oil prices have also undercut ethanol’s appeal.

We think the best way to profit from increased long-term ethanol use is through a stock like Archer Daniels Midland, symbol ADM on New York. Archer Daniels is the world’s largest producers of corn-based ethanol, but also has a broad base of other businesses.

What risk factors have stopped you from investing in oil stocks?

Investing in oil stocks is risky, but the right stocks can bring profits to patient investors. Do you feel like the market is too risky or are you willing to put up with the uncertainty for potential profits?