Is oil a good investment?

The price of a barrel of oil has come down significantly from the spike caused by the Russia-Ukraine war that sent it rocketing to $120.

It is hovering around $80 per barrel as we hit the middle of 2024, but with conflicts around the world impacting some of the major oil producing regions still, a fresh jump in price cannot be ruled out.

Many investors have exposure to oil through various routes and at times it can outperform the stock market in terms of returns.

In this article, we cover:

• What is the impact of war on oil prices?
• What are the risks of investing in oil?
• How can I invest in oil?
• When will oil prices fall in the UK?
• What impact will rising oil prices have on UK inflation?

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What is the impact of war on oil prices?

The price of oil is very sensitive to conflicts around the world. This is because they often impact both the production and transportation of oil significantly.

The outbreak or escalation of a war generally causes the price to rise significantly due to fears over how supply will be affected.

We have had two very recent examples to look at. Russia’s invasion of Ukraine in February 2022 was followed by a notable spike in the global oil price. 

Then in early October 2023, trouble flared up in the Middle East once again. Given much of the world’s oil exports come from this region, instability hits global prices hard. 

Western countries imposing trade sanctions on oil producers such as Russia also pushes prices up.

How is the price of oil measured?

The price of oil is always quoted in US dollars. There are complex economic and historic reasons for this that could be discussed at great length. 

Essentially, it is due the global reserve status of the dollar, and the fact that the world’s largest economy is naturally the biggest consumer of oil. It is therefore the most logical currency to use in such a large, global market. American firms play a major role in oil extraction around the world, which further cements this.

The term ‘petrodollar’, which refers to revenues from crude oil exports, was coined to reflect this.

The unit by which oil is measured is the barrel. This is a metal container that can hold 42 US gallons, or 160 litres in metric terms.

Of course, a given amount of oil is not always separated into individual barrels. Oil can be stored in much larger quantities. However, a barrel is the unit of measurement that is firmly embedded in the global market.

Two main price quotes are commonly used in the market: WTI Crude and Brent Crude. These two always have a similar price and move together. WTI is used in the US, while Brent Crude is typically favoured in Europe and the Middle East.

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What are the risks of investing in oil?

The risk is essentially the same as with any investment; the price can fall as well as rise. This means the value of your investment can go down as well as up.

This is arguably more acute with oil than with a broad portfolio of shares, for example. This is because of how volatile the oil price is, due to the aforementioned issues.

Over long time horizons, the oil price has tended to recover from falls. It therefore may be possible to ride out a dip in price, but if you need the money back in the near future that may not help you.

Another major risk with investing in oil is that climate policy made by governments around the world could significantly hit the demand for oil over time. 

Promotion of electric cars for example, could put downward pressure on demand for oil over the long run. However, we remain some way away from ownership of electric cars being widespread enough for this to be the case.

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How can I invest in oil?

You are unlikely to want, or be able to, acquire actual barrels of oil and store them in your house or garage before selling them on at a profit.

There are easier ways to invest, though. 

Firstly, you can buy shares in oil companies using any of the usual online investment platforms. There are the oil giants such as BP and Shell that everyone knows, but also many smaller producers and oil services firms that you can invest in, once you have done the necessary research.

It is also worth noting that by just buying a FTSE tracker fund or ETF you will have exposure to oil prices, as oil and related companies make up a significant chunk of the index.

Talking of ETFs, there are many ETF products that offer a simple tracking of the oil price, that can be bought in the same ways as shares. This is the purest way to profit from a rise in oil prices alone. 

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Will oil prices fall further?

This is impossible to say for certain. It is likely that an easing of the conflict in Ukraine would significantly bring the price down, but it is very unclear when that will happen.

The price could also come down if Opec+ decides to increase production. That depends entirely on the priorities of the cartel members, however. 

A recession can also bring the price of oil and petrol down as it reduces demand for petrol and other fuels. That, of course, is a double-edged sword, as it would mean a major knock to the economy elsewhere.

What is Opec+?

The Organization of the Petroleum Exporting Countries is a cartel of oil exporting nations which plays a major role in setting the global supply of oil and therefore, its price. The ‘+’ refers to a group of countries that are not officially members but coordinate oil policy with Opec at times.

The Opec members are Saudi Arabia, Iraq, Iran, Kuwait, Libya, United Arab Emirates, Angola, Nigeria, Algeria, Congo, Eqatorial Guinea, Gabon, and Venezuela.

The ‘plus’ countries are Russia, Mexico, Kazakhstan, Oman, Azerbaijan, Malaysia, Bahrain, Sudan, South Sudan, and Brunei.

These nations hold regular meetings where they agree on how much oil to extract and export. In doing so they can control the price of oil to a large degree. 

Their aim in doing this is to boost their national wealth, create strong domestic economies and further their geopolitical goals around the world. 

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What impact does a rising oil price have on UK inflation?

Oil price rises increase inflation in the UK. This is because a rise in the oil price very quickly causes a rise in the petrol price at the pumps.

With petrol being an essential purchase to anybody running a car or transporting goods, it is easy to see why this plays such a major role in the cost of living. 

Energy costs have been a major driver of the bout of inflation seen in the UK over the past two years.

Notably, while oil impacts the headline inflation rate, another important measure called core inflation strips out the oil price, to give a better picture of domestic economic conditions.

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