Have you seen the price of Brent crude recently? It was nudging up towards $120 last time I looked. That was not supposed to happen!
Five months ago, the markets seemed convinced that oil would by now be retreating back from $113. That was considered a high price, but I wasn’t convinced by the bears. And I showed you how you could profit from the situation.
And yesterday, OPEC came out and said it straight. The cartel now expects oil demand to grow by 840,000 barrels per day during 2013. That’s up from its earlier estimate of 760,000 barrels! Yes folks, insatiable demand for oil is coming right at us.
Many commentators and market players were, and probably still are, expecting ‘demand destruction’ (I’ll explain that in a bit) to bring oil prices down to more manageable levels.
But to my mind, the OPEC forecast is right and the analysts are wrong.
The fact is, we haven’t even suffered a supply shock from the Middle East. And oil refuses to budge. Heaven only knows where the price could go if something happened to supply from the Middle East.
Today, I want to take another look at the oil price – and I’ll give you three ideas on how you could play it from here.
Demand destruction my eye!
The idea behind demand destruction is that, as the oil price goes up, the public consumes less of the stuff. Viable alternatives should crop up, like other fossil fuels or even fancy renewables. And people simply use less. Perhaps they buy more efficient vehicles, or use public transport... or maybe even use less electricity, turn off the telly… go to bed early... I don’t know.
And while it’s true that growth in oil consumption has fallen off, the harsh reality is that this is probably more down to recession than demand destruction as a result of the oil price.
The harsh fact is that even as we save a few gallons in the West, many more gallons are demanded in the developing world. And most of these nations have only just started along what could be a very, very long road towards parity with the West.
So even though growth in the West looks sluggish at best right now, some emerging markets could explode, meaning huge demand for oil.
So, for my money, we’re going to see serious demand from developing countries. And despite all the new extraction technologies deployed in the US and now spreading around the globe, supply still can’t keep up with demand. After all, we’re facing declining production in many of the maturing fields that have been tapped for decades.
As OPEC says, demand destruction is far outweighed by demand creation. But that’s not all we’ve got to worry about...
An exclusive report from The Right Side
Do you remember the seventies?
Analysts put last year’s inflated oil price down to the Arab Spring and potential trouble in Iran. As those events have started to fade from public perception, many were expecting oil prices to fall.
And thankfully, there’s been no serious supply-side hiccup. But we mustn’t forget how volatile this part of the world is. I hope things stay calm, but last year showed us how quickly politics can disintegrate in the Middle East.
In 1973, the Yom Kippur war lit the fuse, and oil went from $13 to $43 practically overnight – yes, up nearly four times. Again in 1979, the price bounded up to over $70, this time because of the Iran-Iraq war. You see how quickly oil can go up in multiples when the supply lines are threatened?
Three ways to hedge against Middle East chaos
One way to play a rising oil price would be through a Brent Crude exchange-traded fund (ETF). I explained my reasoning for that in the September article. And in terms of the argument, nothing has changed.
At present, the oil ETFs benefit from a positive roll yield. You can read how it works in the article. If you need a refresher on ETFs, my colleague, Tim Bennett, has a helpful video (you can also sign up to get his video tutorials every week). The long and short of it is that, even if the oil price stays level, the ETF should gradually appreciate in price.
If the ETF sounds a bit esoteric, you could go down the oil equities route. Recently I told you about a London-listed stock, EnQuest (LON: ENQ), that looked like a reasonable bet. Its main area of operation is in the North Sea, which provides a safe haven if something should go wrong in the Middle East.
But if you don’t want to go for an individual stock, you could buy the index. For instance, using a spread bet, you can get exposure to the FTSE oil and gas producers. In fact, I just took a look at the chart (see below), and the index is trading pretty close to the bottom of its Bollinger band. Looking at the chart, I might consider placing an order to open at around the 7,900 level.
Six month chart of FTSE Oil and gas producers
Source: Digital Look
Recently I’ve stressed that private investors are often underweight commodities. I think that in these markets, that could be a very bad move.
Because, beside simply looking a smart investment, betting on oil is also about diversification. Just think about what a Middle East blow-up could do to equity markets. Wouldn’t you want to have exposure to something that should at least benefit?
Even if disaster doesn’t strike, I still think oil is a pretty good bet.
• This article is taken from the free investment email The Right side. Sign up to The Right Side here.
MoneyWeek Tutorials is published by MoneyWeek Ltd.
Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.
The Right Side is an unregulated product published by Fleet Street Publications Ltd.
Fleet Street Publications Ltd is authorised and regulated by the Financial Services Authority. FSA No 115234. http://www.fsa.gov.uk/register/home.do
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.