On Saturday, September 14th, a drone strike from a Yemeni rebel group affiliated with Iran attacked Saudi Arabia’s largest oil production field, taking out 10% of Saudi oil production and nearly 5% of the entire globe’s oil supply. In the wake of the attack, crude oil prices skyrocketed, marked by a 12.62% increase by market close on the 15th. Furthermore, the scramble to find the progenitor of the attack led to fingers being pointed at Iran by the U.S. and the United Arab Emirates despite Iran denying any involvement, further escalating tensions in the already precarious Middle East situation. As of September 20th, President Trump has authorized troop deployment to Saudi Arabia, another indicator of a brewing conflict. However, investors may be able to capitalize on this chaotic situation by investing in crude oil. Let’s break down the potential benefits, and consequences, of investing in crude oil.
Why Invest in Oil?
There are a few reasons why an investment in oil could be beneficial for investors. First off, risk premiums on oil will continue to rise proportionally to the level of political instability in the Middle East. A risk premium is essentially extra rewards to an investor that tolerates the risk of an unstable asset. The conflict in the Middle East is not going away any time soon, suggesting that oil prices will continue to climb in the future. The real kicker, however, is that oil’s risk is less than it appears on the surface. The world’s demand for oil will never go away, at least any time soon, meaning that oil will always remain a valuable commodity. Because of this, investors can feel more confident in investing in oil, with rising risk premiums as a bonus.
Investors must also consider what type of oil assets to invest in as well. Usually, this choice will boil down to an ETF or an oil production company. ETF’s mitigate risk by compiling a basket of stocks into one asset, protecting investors from the exposure found in solo production companies. ETF’s also tend to have generally higher dividend payments than production companies, but this is not always the case. Despite the obvious benefits of an ETF, investing in production companies can still be highly profitable.
Not to get too far into the inner mechanisms of the oil industry, but investors should look at investing in upstream oil production companies, which are generally more profitable than mid/downstream companies. This means the companies are involved in the direct extraction process of the oil, rather than being a middleman. Most of the most recognizable oil stocks, like Exxon Mobil (XOM) and Shell (RDS-A), are upstream production companies.
Why Not Invest in Oil?
As mentioned previously, investing in oil can be especially risky when buying into production companies. These companies bear the risk associated with losing their oil supplies. For example, the Valdez Oil Spill of 1989 tanked Exxon Mobil shares (XOM) nearly 10%. These unpredictable incidents can be catastrophic to oil stocks and severely hinder your assets.
Another potential downside for investors is the existence of The Organization of the Petroleum Exporting Countries, most commonly known as OPEC. This international organization is comprised of 14 countries and controls 40% of the world’s crude oil, according to the U.S. Energy Information Administration. This level of control can potentially be problematic, as the organization can regulate oil prices with unrestricted power, leaving investors vulnerable to sudden drops in oil prices. Further considering the fact that Iran and Saudi Arabia are both members of OPEC, it’s uncertain what will become of the organization if Iran were to be found responsible for the attacks on a fellow member. For investors considering investing in oil, keeping close tabs on OPEC will be an important aspect of asset management.
Future of Oil
Although nearly all investors missed the huge oil spike immediately after the attack, that doesn’t mean there is no money to be made. Part of good investing is thinking one step ahead of the competition. Potential oil spikes may lie in the future, especially after the news that Trump has authorized the deployment of troops and military. Any formal declaration of war or conflict between U.S. troops and Iran is almost certain to lead to an increase in oil prices, due to the conflict’s vicinity to Saudi Arabia and other oil producing countries. Therefore, it’s imperative to stay updated on current events regarding the Middle East in order to judge whether oil is a good investment.
The potential ramifications of the Middle East oil crisis may have far-reaching effects beyond what can be seen immediately. Different variables such as Iran’s place in OPEC, Trump’s itchy trigger finger, and more potential attacks on Saudi Oil fields can and will significantly dictate the course of events in the Middle East. It’s up to investors to decide if they want their money in the middle of such a volatile situation. It all comes down to how you view risk as an investor, and your tolerance for risk-reward.
Financial data from finance.yahoo.com