Monday, October 27, 2008

[wikiHow] How to Make Money As Oil Prices Rise


How to Make Money As Oil Prices Rise


from wikiHow - The How to Manual That You Can Edit

As crude oil prices reach record levels, it seems you can’t go a day without hearing two or three people complain about the price of gas or heating oil. Indeed, the surging prices are a source of concern—and sometimes anger—for everybody. Well, almost everybody: while the rest of us suffer at the pump, some people are actually making money off the situation, and it’s not just CEOs of oil companies that are cashing in. Here’s how you can get a share of the oil boom.

Steps

  1. Do your due diligence. No matter what you’re investing in, you need to make sure you go into the decision as well informed as possible. Reading an investment’s prospectus is a good start, but your research should not end there. Due diligence is the process of researching an investment before you buy in, and it involves looking at the historical returns on an investment, understanding the terms of the investment, and analyzing its future potential. While no one can know for sure how any given investment will fare in the future, you can make a better guess by being well informed.
  2. Think about your risk tolerance. Every investment carries some degree of risk or uncertainty, but some carry far more risk than others. Each person should choose investments based on his or her own risk tolerance, which should be dictated by his or her age and financial situation, the level of diversification in his or her portfolio, and personal preferences. A young person just getting started in investing typically has a greater risk tolerance than a retired person, because the retiree needs a steady income, while the younger investor probably has a steady income and is looking for the greatest return on investment. In addition, the more diversified your investment portfolio, the more risk tolerant you may be, since you stand to lose only a part of your total portfolio if any one investment goes south.
  3. Open a brokerage account online or with a local brokerage firm. Most of the investments listed below must be purchased through a stockbroker or through an online brokerage account. Whether you use a stockbroker or go it alone is up to you. A stockbroker generally charges a higher commission, but you can get more advice and develop a personal relationship. Online brokerages vary in their degree of customer assistance and advising, but may be suitable for some investors.
  4. Consider your options. There are a variety of ways to profit from high oil prices. Some of them are listed below for your convenience. The list progresses from the theoretically highest risk investment to the lowest risk investment, although the actual risk involved in each type of investment will depend on timeframe and the specific stock, fund, or situation you are investing in. Generalizations of risk level are no substitute for performing due diligence on an actual investment prospect.
    1. Buy an oil well. Obviously, if you own an oil well, your revenues increase as oil prices rise. There are, of course, a lot of operating expenses to be considered before purchasing such an asset, and there is a lot of uncertainty, as well. Wells that produce oil inexpensively and those that have large proven reserves are typically not for sale, and those on the market are outrageously expensive. Beyond producing wells, you can purchase exploratory wells or invest in start-up drilling ventures, but such investments are even riskier than they sound. You’ll need a fair amount of money and a gut of steel to get into this part of the market.
    2. Buy oil futures. Crude oil is a commodity and futures are traded on the commodities market. The market has developed a number of sophisticated financial instruments, but the most common is the futures contract, in which the buyer purchases the obligation and right to sell a certain quantity of a commodity on a certain date in the future. Buying oil futures essentially entails guessing what the price of oil will do down the road, and is extremely risky.
    3. Invest in a commodity exchange-traded fund. Exchange traded funds for commodities are like index funds that track the price of one or more commodities. As with futures, these are risky and depend solely on the price swings of the commodity. They are traded like stocks, however, and thus offer a good deal more freedom in buying and selling.
    4. Invest in an oil royalty trust. Oil royalty trusts provide the shareholders with dividends on the profits from one or many oil producing operations. The dividends can be staggering—up to 30% per year or more on the investment—but they are difficult to predict because any given field’s production is subject to all sorts of uncertainties, not the least of which being that the field’s reserves could be depleted.
    5. Buy stock in supporting players. There are only a few large oil companies that are publicly traded and produce most of the world’s oil, and their stocks are usually quite expensive and do not experience tremendous, rapid fluctuations (either up or down) very often. If you’re looking for something a bit riskier (and potentially more profitable), consider buying stock in the companies that supply Big Oil with its specialized tools and research. Some such companies are quite large and diversified themselves, but many are smaller engineering or tech firms that might land a huge contract for a new technology. Or they might just go bankrupt.
    6. Buy stock in an alternative energy company. In the long run, rising oil prices should make alternative energy sources much more attractive. If you want to prepare for this scenario, or if investing in oil leaves a bad taste in your mouth, you can invest in companies that research, design, and produce alternatives to oil. Since it’s hard to say just what will be the big new fuel or fuels of the future, and it’s even harder to say what companies will find the best way of exploiting these fuels, this can be a risky gambit. Ironically, the big oil companies are the biggest players in alternative energy, as well, so don’t overlook them if you’re purely seeking profit from this growing market.
    7. Buy stock in Big Oil. Seven huge oil companies control most of the oil in the world, and their stock prices benefit from record crude prices. What’s more, these companies are large and diversified enough to offer some shelter from sudden drops in oil prices. The stocks are expensive, though, and don’t offer much of a chance for overnight riches. Smaller oil companies offer a bit more risk (and potential return) for more intrepid investors.
    8. Invest in a mutual fund that holds oil company stock. Most mutual funds hold at least one or two oil companies, and many hold stock in some of the supporting companies as well. You’re best off holding a mutual fund for the long haul and choosing a mutual fund on its overall performance and management, rather than on specific holdings, but if you want to bet on oil and expose yourself to a bit less risk, mutual funds may be the way to go for you.
    9. Use less oil. There’s one sure bet on this list, and that’s to reduce your own dependence on oil. Drive less, use mass transit, buy a fuel-efficient car, and improve energy efficiency in your home, and you can partially avoid the burden of rising prices. It may not seem like making money, but remember: a penny saved is a penny earned.

  5. Implement your investment as part of a diversified portfolio. It’s old advice, but it can’t be stated enough: the surest way to make money while protecting yourself from the uncertainties of the market is to diversify your investments as much as possible. No one should put all their eggs in one basket.

Tips

  • Remember the adage: “Buy low and sell high"? Oil prices are booming now, so everybody wants to get in on the action. But will they stay high, or will they plummet? No one knows, but make sure you come to your own conclusions before investing. One good rule of thumb is that if there's a "wikihow" about an investment, it means the market is already oversaturated and it's time to sell.
  • If you’re looking to hedge your stock portfolio with commodities, oil probably isn’t the best choice. If the economy takes a downturn, oil demand is likely to decrease, and the price of oil may plummet along with your stocks.

Warnings

  • This article is intended for general information only. Do not make investment decisions based solely on this information or any other general source of information.
  • Do your own research. Don’t merely trust the advice of others, including your investment advisers. In most cases, if you end up losing money because you weren’t reasonably well informed, you have no one to blame but yourself.
  • Beware the tax implications of certain investments. Taxes can be a pain for any investor, but for sophisticated financial instruments, the tax implications can be extraordinarily complicated.

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Sources and Citations

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