Introduction to Oil Investing

By Duncan Sutherland- Exclusive to Crude Investing News

Oil has been known and used by humans for thousands of years. Herodotus observed the Babylonians using seep oil as pitch almost twenty-five hundred years ago. For most of human history, this bubbling, seeping oil was a curiosity, used for tar, lamps, or medicine. It was not until the mid 19th century that it became a widely sought commodity.

Since then, energy dense hydrocarbons have become central to our way of life. The oil age has spawned suburbs, air travel, industrial agriculture, unprecedented intercontinental trade and mechanized warfare.

As fair warning, investors should remember that “There’s no sense owning oil companies unless you’re convinced that oil has a profitable future”. Peter Lynch’s tongue must have been quite firmly in his cheek when he said this, but it bears repeating nonetheless. If you are beginning to look at investing in oil, you most likely know that barrel prices and company profits are hovering near record highs. Because of this, many investors feel that it will be difficult to afford the initial investment and the rate of return will be too low. This is not always the case.

The first choice facing new investors is what vehicle of investment is best for them. Those with a penchant for gambling might prefer the speculative trading of commodities futures on the New York Mercantile Exchange, while a risk-averse investor should park his or her money in one of the major companies like BP (NYSE:BP), Chevron (NYSE:CVX), Exxon (NYSE:XOM) or Shell (NYSE:RDS.A). Somewhere between the safe blue-chips and the volatile future markets lies the realm of junior oil companies.

Even without jumping into the venture exchanges, new investors can find smaller companies with share prices below $5 in abundance. Companies like Cordero Energy (TSX:COR) and Anderson Energy (TSX:AXL) offer low entry prices and the chance for a higher rate of return.
One common error among new investors is to think that the only money to be made in oil is from companies actively pulling it out of the ground. On the contrary, there are also good buys in companies specializing in engineering, refining and pipelines.

As with other hydrocarbons, oil poses some special investment challenges. Most of it is controlled by nationalized companies, and the major public companies own much of the rest. Where opportunities do exist, national governments may have a change of heart and unilaterally renegotiate the terms of operations for foreign companies.

Thus a good place to start looking is in countries and regions not known for oil production. Countries with nascent oil industries usually provide incentives to encourage growth. A company like Heritage Oil Corporation (TSX:HOC) is a good example, because it has made a conscious strategy of being an early player in new production regions. Although it is operating in Russia and Iraq, it also has projects in Malta, Mali, Pakistan, Uganda and the Democratic Republic of the Congo. Other than Malta, these nations are not renowned for stability. Political risks are significant, but the potential profits of being the first big player in a new region are alluring.

Diversity is a strength in any portfolio. Big multinationals can anchor your portfolio with steady returns, while some exposure to juniors in different regions gives you the chance for a big score. For more background, check out the Introduction to Hydrocarbon Investing.