Three popular ways to invest in oil: the pros and cons

Oil markets have given investors a wild ride in the last few years
Claire McCombe

OIL markets have given investors, among others, a wild ride in the last few years. Before the glut of 2014, most forecaster's medium term price targets only pointed in one direction.

The $150 oil mark was seen as just another staging post, as supply became inevitably scarcer. Expectations are now understandably more diverse, as demand and supply seem to be more balanced today.

Investing in commodities is complicated by physical facts – most of us simply do not have room, or indeed the security arrangements to store barrels of oil or bars of gold in our garden sheds. There are ways to get access to oil nonetheless: we explore three alternatives here, each with its own advantages and disadvantages.

Consumers can buy shares in an energy company such as Shell or BP. This allows a measure of exposure without the inconvenience of having to take physical delivery of barrels of oil.

Alongside that oil shares can (and do) provide investors with an income, in the form of dividends, which can again be an important requirement for investors.

However, investors need to be aware that when buying shares in such a company, you are getting exposure to a range of other factors outside the oil prices. The risks of investing in a company, whether energy related or any other sector, are very different in nature to more direct exposure to commodity prices through futures for example.

Another very popular means of accessing oil, and one that is favoured by more and more investors, is to buy an exchange traded, or tracker, fund.

However, even here an exact match for the behaviour of the today's oil price will be elusive. The investor's return is not directly linked to movements in the price of oil itself, but of oil futures – securities whose value are linked to the price of oil.

Exposure is only possible to the market's expectations of the future development of oil prices, storage costs, and interest rates – all key determinants of oil future prices. the means that structural factors generally associated with the oil market often eat much of the return earned while the tracker is held.

The issues around stock-specific risk can be offset by buying a fund which holds a diversified number of oil company shares, rather than those of a sole company.

Many investment experts favour buying oil share funds, as they offer professional management and diversification, which can protect investors from falls in value and boost returns.

However, funds often give exposure to numerous other companies as well as those investing in oil specifically, meaning investors may not be getting true exposure to oil. Funds can also be a more expensive way to invest as there are extra fees associated with paying professionals to invest on behalf of others.

There is also no guarantee that the manager of a fund can deliver positive returns.

And, as with other investments, you should always be aware that the value of investments in the oil sector – direct or otherwise - can fall as well as rise.

Oil is, of course, a scarce and controversial commodity. Investors in this sector would be well advised to keep on top of the many socio-political influences on the oil price, as well as the longer-term technological trend to carbon-free energy sources.

:: Claire McCombe is a private banker with Barclays Wealth & Investment Management

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