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High Oil and 20-Somethings Investors

6 May 2008 One Comment

I remember my last semester in college in the spring of 2005 when oil was incredibly high at $60 a barrel. It seemed like every market analyst was freaking out. Today, oil is over $120 a barrel. With oil and other commodities getting loads of attention on CNBC and other market news resources, the question is and will continue to be for most investors: Should I invest in oil or have I already missed the run?

When considering investing in oil, it would seem that the present is not a great buying opportunity. Oil has been trending upwards for years and has recently spiked even further. While the issue is intensely debated, it seems possible, maybe even likely, that oil has plenty higher to go.

It seems the analysts and bloggers, when explaining the rise in oil, fall into two camps. The first camp is the crowd that blames the U.S. dollar’s plunge on the increase in oil prices. The second camp is the group that claims that supply and demand fundamentals are to blame for high oil prices. While the U.S. dollar may be a short term factor in a temporary spike of prices, I believe the long term trend has been and will continue to be a result of supply and demand.

Increasing Demand

Demand for oil has been high in the U.S. for years. The real pressure is coming from the growth of the middle class in developing countries such as China and India. As more Chinese and Indian people enter the middle class, their energy consumption increases. Consider that China has over 4 times as many people as the United States and that we still vastly outpace their energy consumption. What will global demend for oil look like when China catches up to the United States in consumption?

Dwindling Supply

I am currently in the process of reading, “The Twilight in the Dessert” by Matt Simmons, and I am amazed at the thoroughness of his research and findings. Simmons explains in detail how the Saudi’s have much less oil than the vast majority of energy analysts and stakeholders dangerously assume. The possibility of running out of oil has recently become an issue as oil and energy gets more attention. A hard look at the world we live in reveals that everything is dependent on energy, and we get most of our energy from oil. A potential supply shortage would be nothing short of a global crisis.

Conclusions and Action Steps

There are convincing arguments to be made for both increasing demand and decreasing supply. If only one scenario comes to fruition, there is still a reasonable argument to be made for higher oil prices. If both scenarios pan out, we could be looking at extremely cheap oil at $120 a barrel.

We talk at length on this blog about finding buying opportunities. Our goal is to outperform the market. Buying at the right time and avoiding a buy at the wrong time is the first step towards an outperforming portfolio.

Finding the perfect entry point for something that has been trending upwards so steadily as oil is difficult. When that is the case, it may be best to split your position into multiple chunks. I would recommend splitting your position into thirds. Determine how much you want to eventually have invested in oil, and buy a position with a third of that total. If prices drop in the short term, invest another third. Eventually, invest the last third.

What if prices continue to rise? Well, you will have made money on your initial position. If fundamentals continue to support higher prices, you may decide to invest additional money.

Ways To Invest In Oil

An easy way to gain exposure to rising oil prices is through the United States Oil ETF (USO). The ETF will rise and fall with the price of oil.

Stocks of companies that benefit from higher oil prices are also ways to play higher oil. Transocean (RIG) provides equipment for offshore oil and gas wells. ConocoPhillips (COP) is an integrated energy company. Chesapeake Energy (CHK) and Apache (APA) are natural gas plays; as oil prices climb, natural gas becomes more popular and also climbs in price. All of these stocks have had nice runs in recent years so invest in thirds as described above.

One Comment »

  • Chris said:

    I would be hesitant to believe that it is mostly based on supply and demand. I really think much of the price is based on a flight to safety by speculators. Supply was reported up (at least for united states) and oil went up anyways.