Get Ready for Higher Oil Prices

In 2011, crude oil will significantly rise in price. This could particularly be a big opportunity for investors. While the oil business has always been profitable, new factors …

In 2011, crude oil will significantly rise in price. This could particularly be a big opportunity for investors. While the oil business has always been profitable, new factors are triggering oil-price volatility. Understanding this will be key in determining the winners and losers in the oil game. See the following article from Money Morning for more on this.

Crude oil is about to skyrocket in price.

In fact, I believe we’ll be looking at $150-a-barrel oil by mid-summer.

For most U.S. consumers, higher oil will equate to higher expenses, and a bigger drain on the household budget. But for investors who understand where to look, these higher crude prices represent a substantial profit opportunity – one that will eradicate any concerns you have about higher household expenses.

And I can tell you precisely where to look. The oil business is – and in our lifetimes, will always be – wildly profitable. But with crude prices set to skyrocket in the New Year, 2011 will be an especially big profit opportunity for investors.

The fact that oil prices are headed higher most likely isn’t a surprise: In fact, the traditional indicators have all been pointing in the same direction for some time now.

But here’s what you probably don’t realize: Oil-price volatility will prove to be the key over the next year. That volatility will separate winners from losers – and absolutely will not treat all oil-related investments equally.

However, if you understand how to play this volatility, it will actually serve as a first-class ticket to some hefty returns.

The "New" Catalysts For Crude Oil Prices

While traditional catalysts will still be of some importance in estimating crude oil prices, they will no longer control the show, or be of much help in selecting the best investments.

In the past, the market would regard five elements as having the most direct impact on crude prices:

• The value of the U.S. dollar.
• Crude-oil inventories.
• Industrial performance as a measure of returning demand.
• Supply constrictions.
• And mergers and acquisitions (M&A).

Those same five factors these days are less indicative of where the market is going or what participants are to profit most from the movement. As we move into 2011, you need to offset the "tradition" with the new persistent and intensifying volatility.

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How to Win the New Oil Game

In the last 10 trading sessions from late October to the end of November in which NYMEX West Texas Intermediate benchmark crude contract prices increased by more than 1%, the OIL VIX was also positive nine times. Given that the figure represents movement over a rolling 30-day period, this result has a clear meaning. The pricing volatility is moving quicker (and up faster) than the OIL VIX can compensate for it.

This will be the norm rather than the exception in the early part of 2011. Absent a collapse in the European euro and a full-blown pan-European credit crisis of major proportions (highly unlikely), the overall strength of the dollar will have less to say about oil prices than in the past. Demand will recover and the market will move into a period highlighted by renewed concerns over adequate supply.

Volatility will merely intensify the upward pressure, because as traders find it more difficult to determine an adequate price for options on their futures contracts, the safe bet is to ratchet the price higher.

Much higher.

We should be looking at $100 a barrel by spring. But by the time we reach mid-summer, that figure could easily move beyond the record price of $147.27 experienced in the speculative bubble of July 2008.

The scenario that we finally see will depend on the level of returning demand and the intensification of the volatility.

There are three specific areas to key on if you want to play the looming run-up – before prices spike. Those three areas consist of:

• Funds, which represent the straightforward approach.
• The oilfield-services sector (OFS).
• The premier "wildcatters," which includes a whole range of U.S. and Canadian minnows that could outperform the big boys with focused projects and by efficiently bringing in fields with lower overhead.
• And the "unconventional" players, such as those involved in shale gas.

The Oil Funds

Several exchange-traded funds (ETFs) allow you to play the oil contracts without actually trading in the futures. The U.S. Oil Fund LP (NYSE: USO) is the best-known.

But there are others, too, including one that provides a way to play the differential between New York and London, between the dollar and euro-base for the actual retail sale of oil products. These other funds are identified in The Money Map Report "2011 Investors’ Forecast Issue," which MMR subscribers already have in hand.

ETFs always carry a tracking discount – which means they will not provide the entire return the underling contracts would. But they’re still a manageable way for the individual investor to participate in the overall rise in oil prices.

The OFS Sector

The crude-oil market is already experiencing a rising push for new production. This has resulted in rapid deployment of drilling rigs and field-evaluation teams.

And before that production hits the market, fields need to be readied, infrastructure constructed and wells drilled and completed. This is the oilfield-services (OFS) sector, and it has already exhibited upward movement.

There’s been a big increase in the amount of dealmaking – especially mergers and acquisitions (M&A) – which means the big are getting bigger as the market leaders continue to consolidate.

Investors can play this trend with an ETF – the iShares Dow Jones U.S. Oil Equipment Index (NYSE: IEZ) – whose holdings include such top oilfield-services players as Schlumberger Ltd. (NYSE: SLB), Halliburton Co. (NYSE: HAL) and Baker Hughes Inc. (NYSE: BHI). And they’ll make money.

But here’s the reality: If you want to make the real money that will flow out of this run-up in oil prices, you’re going to do so by buying shares in these individual companies. That’s where the real money will emerge.

I have several key picks in this sector that I’ve detailed in the Money Map Report forecast issue.

It is in the equity of individual companies, however, that the real money will emerge.

Wildcatters and Unconventional Players

On the production level, a rising pricing tide will not lift all boats equally. However, the main investment returns will not come from the largest companies, but from the best positioned, best structured and best managed medium and small companies.

The development of the last five years has put a premium on extracting crude from fields of all sizes. However, the market leaders – the likes of ExxonMobil Corp. (NYSE: XOM), Chevron Corp. (NYSE: CVX) and even the beleaguered BP PLC (NYSE ADR: BP) – need economy of size to remain profitable. That means they bypass a number of fields because they are simply too small for their operations.

That provides significant opportunity for the aforementioned U.S. and Canadian "minnows." In the "Forecast" issue, I detail one particular investment that will enable investors to really profit from this sector.

The New Year will also see a continued move away from conventional sources of crude toward newer, unconventional sources. And that’s true for both natural gas and for oil. In terms of natural gas, we’re talking about shale gas. For crude, oil shale, heavy oil, bitumen and Canadian oil sands will occupy a more important position. North America will progressively turn to such sources as the traditional conventional crude sources continue to decline.

This article was republished with permission from Money Morning.


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