“Come and listen to a story about a man named Jed
A poor mountaineer, barely kept his family fed,
Then one day he was shootin at some food,
And up through the ground came a bubblin' crude.
Oil that is, black gold, Texas tea.
Well the first thing you know ol' Jed's a millionaire,
Kinfolk said Jed move away from there
Said Californy is the place you ought to be
So they loaded up the truck and moved to Beverly”.
So goes the song from the popular ’60s TV show “The Beverly Hillbillies”.
While it is safe to say that most of us are not holding our breaths for such fate to strike us, transforming us into oil tycoons overnight (though it would be nice), many of us can, and probably should, consider including oil investments as part of our trading strategy or diversified portfolio.
Stopping short of stocking up on barrels of oil in our garages and turning our properties into neighbourhood gas stations, investors these days have various means of investing in one of the most heavily traded energy commodity in the world. These will be discussed in greater detail below.
Slick fundamentals
With the projected rebound in global growth (particularly from China and India), the International Energy Agency, in its recent memo, indicated that global oil demand is expected to rise at a higher rate than previously anticipated over the next year. World demand for 2009 is expected to be 84.8 million barrels per day, an increase of 400,000 barrels from the previous forecast. 2010 is expected to bring in a daily demand of 86.2 million barrels, a further increase of 1.4 million barrels per day!
While this represents demand that is on par with 2007-2008 levels, things are definitely looking better from an economic perspective.
China and India are the fastest-growing non-OECD economies, and they will be the key world energy consumers in the future. Since 1990, energy consumption as a share of total world energy use has increased significantly in both countries. China and India together accounted for about 10 percent of the world’s total energy consumption in 1990, but in 2006 their combined share was 19 percent. Strong economic growth in both countries continues over the projection period, with their combined energy use increasing nearly twofold and making up 28 percent of world energy consumption in 2030 in the reference case. In contrast, the U.S. share of total world energy consumption falls from 21 percent in 2006 to about 17 percent in 2030.
Factors affecting Oil Prices
While a case can be drawn for stronger oil prices based on the bullish economic scenario, we have found that short term prices of crude oil can be swayed by a wide range of factors, ranging from fundamental supply and demand levels to market news and speculative behavior.
Over the long term however, factors that impact oil prices are more clear, and include:
• OPEC Production Levels: If concerns over weak demand arise, OPEC may decide to cut production. If however oil-producing nations are looking to increase revenues, increases in supply could lead to lower prices.
• Alternative Energy Production: Demand for crude oil and natural gas will depend significantly on the development of alternative energy industries in coming decades. If solar energy and wind energy become viable sources of clean, renewable energy, demand for crude oil could diminish. If however, these industries continue to encounter obstacles on the road to sustainability, prices may continue to be propped up by dependence on oil.
• Geopolitical Tensions: With much of the world’s proven oil reserves located in the Persian Gulf, the level of world output depends in large part on the stability of an occasionally unstable region. In the event of disruptions in crude oil production, the operations of companies in the energy sector may be impaired.
• Natural Disasters: Generally unpredictable in nature, natural disasters, particularly hurricanes, can have a major impact on prices of oil and gas. Devastating storms usually result in significant output declines, months of recovery time, and extended reliance on alternative sources of energy.
• New Discoveries: In recent years, we have seen major discoveries of crude oil off the coast of Brazil and huge natural gas reserves near Louisiana. To the extent that major discoveries are made going forward, prices may decline in response to increased global supplies.
Differing Opinions
Not surprisingly, there are different opinions on the future direction of crude oil prices. Some analysts believe that demand fundamentals are too weak to support current $75 per barrel levels, particularly given the precarious state of the economic recovery in many oil-thirsty countries. Others believe crude is poised to skyrocket. In a recent research note, BOA-Merrill Lynch said prices may climb above $100 per barrel next year as demand rebounds in emerging markets and investors look to hedge against a further slide in the value of the U.S. dollar. Some have also pointed to Exxon Mobil’s renewed efforts to expand its reserves in Ghana and elsewhere as an indication that the industry is bullish on oil prices over the long term.
Investment Options
Regardless of the underlying reasons for changes in oil prices, investors who want to capitalize on energy price fluctuations have a number of options. One simple way for the average person to invest in oil is through stocks of oil drilling and service companies. Several sector mutual funds invest mainly in energy-related stocks as well. Investors can gain more direct exposure to the price of oil through an exchange-traded fund (ETF) or exchange-traded note (ETN), which typically invest in oil futures contracts rather than energy stocks. Because oil prices are largely uncorrelated to stock market returns or the direction of the U.S. dollar, these products follow the price of oil more closely than energy stocks and can serve as a hedge and a portfolio diversifier. Investors have a number of ETF and ETN options to choose from, such as a single-commodity ETF (e.g., oil only) or a multi-commodity ETF that will cover a variety of energy commodities (oil, natural gas, gasoline and heating oil). Alternatively, commodity CFDs (contracts for difference) are new innovative instruments that offer a flexible means of trading small lot sizes rather than those stipulated by the exchanges. For example, the US Crude CFD is for 25 barrels of oil versus 1,000 barrel sizes traded on the Nymex exchange on futures and options contracts.
As with all investments, investors should do their research or seek the advise of an investment professional prior to committing their money.
--
StoneBridge Group is an Australian-owned trading house (accredited with the ASX and NZX exchanges) providing advisory and execution services on Foreign Exchange, Commodities, Futures & Options, Shares & CFDs.
“This publication has been prepared on behalf of and issued by StoneBridge Securities (NZ) Limited (“StoneBridge”). This is not an offer to deal in any financial product and is not specific advice for any particular investor. StoneBridge believes that any information or advice (including any recommendation) contained in this publication is accurate when issued but does not warrant its accuracy or reliability, and is not liable for the future performance of transactions or for any loss or damage arising in connection with this publication. A full Disclosure Statement in accordance with the Securities Markets Act 1988 is available free of charge on request. ”