Should You Buy Oil ETFs Or Oil Stocks?
Oil is an interesting thing to think about. It is something that we consume daily and it’s also an interesting investment, or perhaps more accurately put, an interesting speculative opportunity.
When determining if you should put money in play to take advantage of oil going higher (or lower), there are many factors to consider. We’ll start with the fundamentals.
The Fundamentals For Oil
While I’m not an energy expert, I will address a couple high-level fundamental points that I believe make oil a sound long-term investment:
- The idea of peak oil – This is a concept that simply says that we are running out of oil. It is debated greatly on both sides, and it’s hard to say what the correct answer is to this question; however, most experts do believe that the easy oil is running out. Basically, we have plenty of oil, but the oil that is affordable to burn is running oil. Thus, we will have oil down the road, but it will cost much more to get out of the ground, and therefore, the price oil should rise over time.
- Global increase in consumption – While the “easy” supply is going lower, the demand should continue to rise globally, mainly due to the growth of countries such as China and India. The opposing force to this equation is the rise in alternative energies, but I don’t see this as being enough to counter-act the growth in consumption from the emerging markets. Yes, temporarily we have had a drop in consumption due to the high price of oil, but I think we’ll simply consume until we get to those high prices again. One person once asked me, what does the price of gas have to be for it to affect your behavior? I said probably $4-5 range. He responded with, well, that is where the price of gas is going then.
I believe that these long-term fundamentals are definitely in tact. Now, over the short run, we could easily see a downturn in oil prices. If the U.S. economy continues to struggle, or even moves closer to a “depression” we could easily see oil back in the $30’s.
Even if these downturns happen, I believe they are still temporary as oil will go higher even if its a few years from now. As a 20-something investor, I am completely comfortable with such a time frame especially if my confidence in the move higher is pretty good. A great way to play this is to buy high dividend stocks that will pay you while you wait for oil prices to skyrocket (this is one of the options detailed below).
- ETFs that attempt to track the price of oil: USO & OIL – these ETFs have their limitations as they use derivatives and futures contracts to mimic the price action of oil.
- Leveraged ETFs such as DXO attempt to deliver twice the return of the spot price of oil. In addition to the standard limitations of an ETF that tracks a commodity spot price, this has even more factors due to the leverage that must be fully considered before buying.
- If you’re looking to play the short side of the oil trade, extreme caution should be used. DTO is a short oil ETF that can be used to gain exposure on the short side.
Oil Company Stocks & ETFs
In addition to playing the spot price of oil, oil companies can be owned to gain exposure to oil. In addition to the potential for capital appreciation, many of these stocks come with generous dividend yields.
- ExxonMobil (XOM), ConocoPhillips (COP), British Petroleum (BP) are all large energy companies that pay a nice dividend yield.
- ETFs to be considered that hold baskets of energy companies or energy-related companies are: DIG, OIH, XES, XOP and PXJ
While this fundamental long-term view of oil makes the current short-term price of oil less important, let’s still take a look at where we are (as of September 25, 2009). Currently oil is off the highs of the year in the mid $60’s. Oil has rebounded from the $30’s. I think that while more attractive entry points are probably around the corner, establishing a position in some of the above mentioned securities is probably a good idea. I definitely like the idea of buying dividend paying energy companies as a fairly conservative way to play oil at this point.