I don’t know about you, but when I’m putting petrol in my car these days I almost have to look away. As the price of Brent crude approached $125 last month, I even started to consider public transport.
Governments are anxious about oil too. Last week, the US took the extraordinary step of releasing oil from its strategic reserves in an effort to keep the oil price down.
But we’re going to have to get used to high prices. I think oil prices are going to stay high for some time.
And I’d like to recommend a way for you to profit from that.
You’d better get used to it
For all the intrigue of America’s surprise intervention in the oil market last week, it won’t have much of a long-term effect on the price of oil. I mean how long can they keep these stunts up? They’ll have to replenish the store-cupboard at some point. This was just a short-term fix.
You’ll also hear how OPEC, the oil producer cartel, wants to increase supplies because they don’t want a high oil price. But that’s a load of rubbish too. Of course the oil producers want high prices. They’re raking it in all the time oil is above $100.
No, what OPEC doesn’t want is a drop off in demand. And it’s not so much the actual price that spurs a drop in demand, as how quickly the price hits a new high.
What OPEC needs to do is temper ‘shock’ at the petrol pump. Because when people are shocked, they may change behaviour.
That’s why oil prices tend to rise in a whip-saw motion. Oil makes a high, and then falls back a bit. As it falls back, people get used to the new price level.
If it goes up too far and too fast, you end up with protests in the streets. In 2000, fuel protests paralysed Britain for 7 days. And yet, prices were cheap. It’s just that oil had shifted sharply from around the $20 mark to nearer $30.
Just imagine if you’d told those guys that oil would be trading at over $100 in a few years time!
The point is that OPEC doesn’t want the price to go up so fast that it causes people to cut back on oil. They don’t want power generators to moth-ball oil plants. They certainly don’t want to cause a recession and they’d certainly prefer it if you ditched all those sustainable energy ideas.
So the producers want to go easy on the accelerator pedal. But make no mistake, the oil producers can and will get away with higher oil prices. By the time you get used to oil trading regularly above $100, then you can expect the market to make an assault on the $150 mark.
But oil stocks are priced for a fall
The thing is that oil stocks have not kept in step as oil has esacalated in price. Here’s a one year chart of European oil producers (in blue) versus Brent crude (in green).
Source: Yahoo finance
(Click on the chart for a larger version)
The chart clearly shows that oil stocks haven’t performed as well as the underlying commodity over the last year.
That’s odd. You’d think the stocks should outperform the oil price, because unlike a barrel of Brent crude, which you can only sell once, an oil stock represents many years of future production.
If the market believed that oil prices (remember that’s the green line) were staying high, then the stocks (blue) should be much higher.
Get some exposure while it’s cheap
In the past, I’ve had to fight the urge of investing my entire pension fund in only gold and black gold. Though my heart wants to home in on these commodities, my mind urges diversification.
And I guess it’s lucky for me that my mind won out. There’s no doubt that the Macondo oil spill has re-rated the whole oil sector. The risks of deep-sea drilling and environmental catastrophes are now in the stock prices.
But there’s still opportunity in the sector. I think oil prices will carry on upwards for decades to come. You never know, in ten years time, $100 oil may look cheap!!
And that means the sector looks cheap today. It offers us a good price for a play on rising oil.
If I’m wrong and oil heads lower again, then it doesn’t matter. It’s already in the price.
On Friday, or next week, I’ll be looking into a little quirk in the oil markets. I’m going to use this quirk to highlight some stocks that could be the best bet on the sector.
• This article is taken from the free investment email The Right side. Sign up to The Right Side here.
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