This time last year, we recommended a very effective short trade on crude oil using an exchange-traded fund, ETF Securities' short oil (the TIDM is SOIL). By the time we advised closing the trade, it had returned a 55 per cent profit, not including currency-related gains.
But the ETF Securities instrument is not the only ETF to track the oil price, and ETFs are not the only way to short oil. You can do so with spread bets, fixed-odds bets and contracts-for-difference, too. There are advantages and disadvantages to all of these approaches. Spread betting and fixed-odds profits are free of capital gains tax (CGT), and transactions don't attract stamp duty, either. CFDs and ETFs are also free of stamp duty, but do attract CGT on any profits above the annual CGT allowance.
You could, of course, just as easily go long with such products, too. You can find comprehensive guides on how to use short-term trading products on our website and you can also search data for different ETFs.
Because oil is traded in dollars, there may be exchange-rate risks for UK investors. Last year, this worked in our favour; our above-mentioned short-ETF was boosted during the US dollar strengthened against the pound, turning a 55 per cent underlying gain into an actual profit of more than 70 per cent. However, this might not always be the case.
Also, be aware that none of the above asset classes generates any income – so really, you are not investing, but speculating on a price movement.
Funds
Most of the traditional actively-managed funds that invest in the energy sector do so by buying shares in oil producers and related companies. One of the favourites among independent financial advisers is the Investec Global Energy fund (the MEXID is YFGEFA), while for risk-takers, there's also the Capita Junior Oils trust (CGJO).
Oil shares
The more traditional way to play oil prices is by buying shares in oil-producing companies. However, these days, the likes of Shell and BP rarely move in lock-step with the oil price. The oil price might have doubled since February, but shares in these two 'super-majors' are little changed over that time. They do, however, pay reasonable dividends out of their vast cash flows, and reinvesting those dividends can, over the long term, help produce a solid performance.
At the other end of the scale, oil explorers can offer huge upside. Typically, these have little in the way of production, profits or cash flow, and don't pay dividends. But exploration drilling can, if successful, energise their share prices. Bear in mind, though, that historically dry wells significantly outnumber successful ones. Small oil shares are risky.
In recent years, many investors have been attracted to medium-sized groups such as Dana Petroleum, Tullow Oil and Premier Oil. These have ongoing production, make profits, generate cash and in some cases pay small dividends. But they're still small enough for exploration success to make a real difference and, because in many cases they do not hedge their output, they're fully exposed to rising (or falling) hydrocarbon prices.
A fourth option is the burgeoning oil and gas services sector. This comprises firms that supply equipment, technology and services to oil producers and explorers. As the search for oil becomes ever more difficult and costly, so the expenditure on new technology keeps rising.
You can read more articles about oil producing companies on our website; just go to Companies/bySector and choose either oil and gas producers, or oil equipment and services.
