Understanding Upstream and Midstream for Oil Investments
We often hear the term “oil market” as a blanket statement, when, in reality, it’s a complex industry with several key players. Consumers are most familiar with the downstream market because it is made up of refineries and marketing (think major gas stations).
With the oil industry being one of the most global markets in both production and consumption it’s worth noting that looking domestically and internationally for data is incredibly important. Understanding some of the individual pieces can lead to better investment decisions overall. Let’s take the upstream and midstream markets as a good place to start.
The Upstream Market
The upstream sector of the oil industry, also called the exploration and production sector, can be best described as the portion of the industry that finds and harvests oil and gas. Through exploration and test drilling, companies can locate new oil fields and tap into them for production. This part of the overall industry is furthest from end customers, so most of these operations result strictly in business-to-business transactions. Such companies and functions include rigs, research, industrial machines and even vertically diversified companies with more household names.
The upstream market is important to watch when making oil trading and investing decisions because it signals where the market is going, right from the source. If an exploratory project of a new oil field was successful, you can be sure that the oil market will be affected. It could lead to cheaper production, resulting in lower prices and beating out competitors.
The Midstream Market
The midstream market does exactly what you would guess: It bridges the upstream to the downstream. Main components of this area of the oil industry are processing, storage and transport, like major pipelines to supply various consumer areas. This specific market can be broken down into large-cap, mid-cap and small-cap companies. This segmentation allows investors to assess the risk and return possible for each company.
The most important aspects of this market are less economic and more political. Getting approval for large pipelines takes a lot of money, political clout, and public buy-in. Carefully tracking what a company is looking to do and how the public might react is a useful way to gauge when to buy and when to sell in the midstream oil and gas market.
The Vantage Point
The true kicker is taking advantage of the inter-workings of the upstream, downstream and midstream markets. Parsing the useful information from the fluff is not always easy, nor is making meaningful connections between events. As a general rule of thumb some key market information to look out for might include:
- New technologies for finding, locating or extracting oil and gas: This could indicate increased global supply or a more cost effective way of finding and extracting oil, both of which can lower oil prices across the world.
- Vertical acquisition: If a vertical acquisition occurs (a refining company buys a pipeline company) this could indicate that they are creating synergies in-house and cutting out costly business-to-business margins.
- Horizontal acquisition: When a refining company acquires a competing refining company then the market’s competitors have shrunk, giving more power to the last companies standing. They will effectively have more control over production, research and development and will own more of the business-to-business and even business-to-consumer relationships.
- Discovery of new oil and gas sources: The extent of resources found in a discovery could greatly sway the ripple effects on the market. With a new source, especially in an unexpected region or from an economy looking to become energy self-sufficient this could have significant impacts on the global market.
Making connections between news events is not simple and shouldn’t be the only piece in your investing strategy. However, when paired with meaningful data it can prove to be a powerful guide.
As with any investing, diversification is key. Even in a generalized oil market downturn you can still find upside in one or more of the smaller pieces of the industry. Hedging your risks by investing in multiple areas of the umbrella oil market can help you develop a strong baseline of investments and could give you upside to invest more over time.
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