Weigh the risks when investing in oil companies

With crude prices moving higher, its easy to get excited about potential

Derek, is now a good time to invest in energy companies?

With the price of crude starting to move higher it’s easy to get excited about the potential of making money by investing in energy companies. However, before you dive straight into a barrel of oil it’s important to consider your investment objectives and be sure you’re comfortable with the risks you’re taking.

The price of oil has moved notably higher since earlier in 2016. In February we witnessed a stunning decline in the price which broke below $30 per barrel for the first time in many years. Since that point, the price of oil is closer to $50 which has led many to believe that the worst is behind us. While this may be the case an investor should understand all risks before moving forward with a strategy.

Investing in companies where the profits change based on the changes in commodity prices (such as oil) can be a daunting venture. Many factors can influence the price of commodities such as world events, political regimes, and changing weather. As such, predicting the correct direction of the price of oil and therefore the companies you’re investing in can be a challenge at the best of times. With this in mind, be sure to have a discussion with a Wealth Advisor and decide if you’re willing to accept the risks before proceeding.

If investing in energy companies makes sense for your portfolio there are a few different ways you could proceed. For example, you could buy shares in a single company, invest in numerous companies, or perhaps buy a group such as an exchange traded fund (ETF) or mutual fund. There are advantages and risk to each.

If you buy shares in a single company you are exposed fully to whatever happens to that one name. If the price of oil moves higher, this one company also needs to manage their finances and operations accordingly to ensure that their shares move higher as well.

It’s not as simple as looking at the past results because the balance sheets of many companies were hurt notably during this decline. If you decide to pick one single company, be sure you understand the financial strength of this name before proceeding, a qualified Wealth Advisor can help with this.

One way to reduce your risk is to consider buying shares in multiple energy companies that operate in different sectors of the oil and gas business. The example is that you could buy shares of a company that operate in the oil sands, another that is a pipeline company, one that is actively drilling, and another that caters to the service and maintenance of these companies. The point is that you’re spreading your investment between various companies that operate differently and ideally reducing your risk from buying just one name.

Another consideration would be to invest in a mutual fund that handles the diversification on your behalf. You may decide to buy a fund that invests purely in oil and gas companies and actively buys and sells the holdings as they see fit. The advantage here is that the portfolio manager does the stock picking and research for you.

You could also buy an exchange traded fund or ETF. In simple terms, an ETF is a basket of securities that invests using a predetermined method. The example would be that an energy ETF may invest automatically in the largest energy companies in Canada included in a specific index. The larger the company, the more of your money that gets invested in that one name. ETFs can provide simple access to a basket of securities. Note that ETFs often do not have a portfolio manager to monitor the companies you’re investing in; you’re simply blanketing the entire sector.

Finally, you can also buy an ETF that tracks the price of oil itself. If you don’t want to worry about the financial strength of individual companies and just want to profit on the increasing price of oil, this may be your best bet.

Prior to making an investment decision I strongly recommend discussing your choices and your overall investment goals with a qualified Wealth Advisor. They should be able to explain all risks associated with this venture and guide you to make the decision that best aligns with your objectives.

Happy investing!

Derek Fuchs

Senior Wealth Advisor

Scotia Wealth Management

Derek Fuchs is a Senior Wealth Advisor with Scotia Wealth Management in Red Deer and holds the designations of Chartered Investment Manager, Certified Financial Planner, Financial Management Advisor, and is a Fellow of the Canadian Securities Institute.

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