The price of a barrel of oil traded above $50 last week, receiving considerable less notice than when the price of oil surged above $100/barrel early in 2008 and its astonishing collapse to approximately $32/ barrel in December. What is fueling this incremental increase in the price of oil and is it here to stay?
Everyone seems to have an opinion about why the price of oil has begun to rise again. Among the most popular ones are:
- Inflation: commodity prices tend to rise in anticipation or in reaction to inflation and the consensus is forming that the stimulus packages are solving one issue (the credit crisis) by creating another (inflation caused by the printing of money).
- Short term Supply is decreasing. As I wrote before, OPEC has indicated that they believe a “right” price for a barrel of oil is $75 and, given their ability to impact supply through production cuts, what OPEC wants, it eventually gets.
- The Market is correcting itself. Many believe that the fall in the price of oil was due to an over-reaction in the market which is now correcting itself.
- Global uncertainty. We are sadly beginning to hear about soldier deaths in Afghanistan, coinciding with a NATO offensive being undertaken in that country which will only intensify with the deployment of 17,000 additional troops from the U.S. The price of oil tends to increase during times of conflict given increasing consumption of oil to feed the military machine and the threat that supply may be cut off.
If nothing else the yo-yo effect of the price of oil reinforces that one should not invest based on emotions. Many investors got giddy and bought oil stocks when it peaked and sold when oil bottomed in a panic.
Where will the price of oil go? No one know for certain but consider that the price of oil is mostly independent of government policy since it is a commodity with finite supply. Additionally, while the much welcomed green movement may help us ween ourselves from fossil fuels, do remember that plastics, used to produce alternative energy sources like wind power, is a chemically modified form of petroleum. Finally, the proposed Suncor Energy acquisition of Petro Canada represents a 25% premium on the 30 day weighted average of Petro Canada share.
These are signs that we may never see super cheap oil again. But whether we will see super expensive oil or some equilibrium between super cheap and super expensive oil is a question no one really knows for certain.
If you want to invest in oil stocks and want to play it safe, think about “integrated” oil and gas companies that pay dividends- these are companies that explore, refine and sell oil and gas to you and I (as opposed to companies that only produce). Think of names like ConocoPhillips, Exxon Mobile and BP.
March 24th, 2009 at 10:47 am
How do you invest in oil? Stocks, ETFs?
March 24th, 2009 at 11:26 am
I read somewhere that cheating on quotas is rampant among OPEC members. And the cheating increases as oil price drops because as revenue decreases, the members try to boost it by pumping out more oil, which in turn further depresses prices. I’m not sure how prevalent this practice is and the effect it has on oil prices.
March 24th, 2009 at 11:30 am
Tom- I own Husky Energy as part of my dividend portfolio.
March 24th, 2009 at 11:35 am
CC- The members of OPEC are known to play fast and loose with the rules. I cannot comment on the quota cheating but there is belief that provable reserves have been over-stated by several members of OPEC.
March 24th, 2009 at 3:31 pm
I bought USO at $35 to invest in oil. At the time the tracking grap wasn’t as bad. Most of the stuff I read said USO was one of the best ways to invest directly in oil. Since then I’ve come to realize that USO the best of the worse. I’m considering selling because I can’t stand to cheer for the increase in oil since gas prices usually follows.
March 24th, 2009 at 5:30 pm
What do you think of companies like Penn West and Baytex, the income trusts from out west?
March 24th, 2009 at 5:50 pm
Mfd- I do know enough about USO to comment. Why is it one of the worst ways to invest in oil?
Geoff- I would argue that oil and gas trusts are more sensitive to price change than oil and gas stocks since its payout ratio is so much higher and there is smaller room for error so they tend not to be great downside risk vehicles.
March 24th, 2009 at 9:05 pm
It’s not the worst. Its the best of the worst. There is no real good way to invest directly in oil. Several ETFs try to do it with varying degrees of success. USO has been stated as being one of the best across several publications but it has its issues. USO works by rolling over 1 month futures contracts which has part of the tracking issues with the real price of oil.
USO is so large that when it rolls over its contracts it accounts for I believe 25% of all contracts (might be more) which means they artificially inflate the price of contracts when they go to rollover. They’ve tried to resolve this recently by spreading their rollover period over 4 days. See the following link:
http://shockedinvestor.blogspot.com/2009/03/uso-rollover-of-oil-contracts.html
Another issue is that because USO tracks oil using futures contracts it opens them up for tracking issues because of the contango they experience when they rollover their contracts. I’ve only recently begun to understand the complicated world of futures trading though I’m a far way off. See the following about the contango: http://www.smartmoney.com/investing/etfs/contango-and-cash-19323/
Maybe that’s the problem and a lesson learned for the future. I didn’t fully understand how this etf tracked oil and that should have been a warning sign to stay away. I really didn’t have enough experience with the more exotic ETF’s.
March 25th, 2009 at 10:15 am
MFD: Interesting break-down of a product I am not familiar with. Thanks.
March 25th, 2009 at 11:16 am
I went in pretty hard to oil companies during the price crash in to the $30′s. My biggest motivation for this is due to the rapidly declining oil production in many of the world’s oil fields. Gulf of Mexico and the North Sea are two great examples of past productive oil fields that are pumping out less and less volume as each year goes by. Whether Saudi Arabia truly has the reserves they state or they have inflated their estimates as most of OPEC has (their allowed OPEC production rate is a ratio of their stated reserves, so it is in their interest to over-inflate their reserve estimates). With the global recession going on, oil demand is down, but not down nearly enough to offset the decline in production. Add to that the sudden halt in new oil exploration and development and we’re setting ourselves up for a major oil supply crisis in the next 2-5 years. The recent rise to $145/barrel may look like nothing if we suddenly find supply incapable of keeping up to demand.
March 30th, 2009 at 6:38 pm
I plan to short oil
March 30th, 2009 at 9:37 pm
Moneymonk- any reason why?
April 1st, 2009 at 10:41 am
[...] first rule came to fruition while I was posting some comments over at Thicken My Wallet about my ownership of USO Oil ETF. I came to realize that I wasn’t following the most [...]