Which Vehicle Is Best for a Long Bet on Oil?

What's the biggest payoff ratio for a long oil bet?

My arguments are simple supply and demand factors such as:

1. Demand is only one way in the long term, given China and India's economic growth and the human population's growth in general.
2. Alternatives to gas and oil are not really economically feasible yet (read: orders of magnitude differences to overcome still).
3. Unmitigated worldwide long-term demand for the luxury of transporting millions of tons of humans and products across the globe for travel and trade in goods and foodstuffs (financial crisis be damned).
4. Peak oil has apparently arrived in the form of declining output in numerous majors such as Mexico's Cantrell oil field and the North Sea.
5. |The U.S. government's stupidity in not allowing serious potential to be developed in the "homeland" (talk about Homeland Security getting something right!).
6. OPEC's continuing cuts in production and the apparent willingness to stick to it (quite contrary to an individual country's best interest).
7. I still choose to drive a huge van (albeit "mini") 50 miles per day commuting!

From a glossary of Futures: If the hedger will need the commodity in the future, he will hedge by buying calls.

I certainly will be needing oil in the future to get to my J-O-B!

I have been reading here on the contango vs. backwardation cycles and what type of markets (flush vs. tight) produce which type of pricing structure. Very interesting, because ETFs based on the same commodity produce very different annual rates of return as a result of a difference in the volume of near-term vs. long-term contracts that are bought and sold. And here I thought ETFs were simple. Ha!

ASIDE: At this juncture I must admit to losing a huge percentage, but small nominal dollar amount, in DXD which has behaved as it should. This investing thing is making me feel foolish given the market's exuberance in the face of terrible fundamentals such as rising UE and worldwide deflationary forces everywhere in prices (see ISM) pointing towards a meltdown in CRMs and close behind insurance company earnings, not to mention another wave of Alt As (whatever those are!?) and ARMs.

So I ask for your opinions... what vehicle is the best bet for long term oil bets? My guess is calls.

Comments

[antiquary:]

Canadian energy trusts, for my money. Not least because we import more from them than from any other country, and transportation costs, lower for us than for, for example, China, don't mean nothing.

Though as to the "stupidity" of the government in not allowing more domestic production-- despite the offshore possibilities, there just isn't any way to make a significant difference with our own oil reserves. We have no serious untapped fields. ANWR, for example, contains even in the most optimistic estimates about 7 billion barrels, or about a fourteen-week supply at world usage rates.

May 08 09:59 AM

[Michael Fit...:]

the best vehicle for a long bet on oil:

www.autoblog.com/2008/...

i just wish toyota would put it in production!

May 08 10:22 AM

[Uncle Pie:]

if you think the price of a commodity is going to rise, the most earnings leverage will be found in the high-cost producers, contrary to what you might think. In the case of oil, we are talking the producers in the Canadian oil sands. The pure play here is Canadian Oil Sands trust (COSWF). Other companies with significant exposure to the oil sands include Canadian Natural Resources (CNQ), Petro Canada (PCZ) which is merging with Suncor (SU), and to a lesser extent, Nexen (NXN). It appears that the market applies very little premium these companies despite the fact that an oil sands mine offers a pretty steady rate of production for 40 or 50 years with NO production decline. Production from a conventional oil field declines steadily, with a profile that looks like the right hand side of a bell curve. Other opportunities in frontier, high cost areas are in deepwater, the best players here would include Brazil's Petrobras (PBR) although usually the Petrobras preferred is the better buy (PBR'A), Norway's Statoil (STO) and France's Total (TOT). This writer owns shares in all the above mentioned companies. US trading symbols are shown: symbols are different in the respective home countries' markets. All the companies have excellent investor presentations on their websites: check them out!

May 08 10:44 AM

[bradiop:]

I agree some form of oil asset makes good sense.
I would add if one feel inflation is in our future; driven by our borrowing and printing money, then investing in Canadian oil related company becomes play on the oil theme and hedge against inflation.
I personally have positions in Canadian Oil Sands (coswf) and Enerpus (ERF)
Good luck.
brad

May 08 11:10 AM

[EX-AD-MAN:]

If you're going to allocate only 10-15% to oil, leveraged long funds like DXO are hard to beat. DXO will not systemically return 2x long term (more of a day vehicle) but should oil bump into $100 bbl again, and it might, that 10-15% allocation might become a 40-50% allocation in a blink regardless of how it performs. Personally, I agree that long term there are hardly any safer bets than what is literally the life blood of the global economy = OIL.

May 08 01:22 PM

[donzelion:]

While I agree with much of your basic analysis, I'm also pretty confident that petrol can take its time to make another big move up. I like getting paid while I wait, and I like mixing things up a bit. I'd choose one Canadian royalty (PCZ), one oil major (BP), one refiner (VLO), and then take your pick on USO or USL. My total petrol exposure is about 10% of my portfolio right now, as much as an anti-inflation hedge as anything else.

May 08 01:25 PM

[Whippet:]

Look at the LEAPS bull call spreads on liquid optionable securities for some interesting high risk/reward plays. I like Jan 2011 spreads on USO (35/45 costs 2.85 today and returns a max of 7.15 (250% profit) if USO climbs 35% in 17 months). You can tweak these to your level of bullishness. I've made a 100% return on a similar play opened 3 months ago already. You can also buy ATM or ITM LEAPS and sell near month, higher strike calls to pay for time decay and lower your basis. You obviously forsake dividends with this strategy and it doesn't work well on some tickers.

May 08 02:35 PM

[Adrian:]

I have done very well and will remain with OIL. Bought at $18 three weeks ago and directly tracks the oil futures price. Made over 15% in a couple of weeks.
I agree with the writers' logic. Nobody really needs Citi, GM or GE shares but everybody needs oil. Not just for gasoline but for aviation and shipping fuel, plastics production and so many other parts of our lives. It is as vital for human life as water (now there's a long term investment). Wars increase the price, demand is unlikely to reduce, even a global depression only drove the price briefly to $35. There is little chance of $35 again but a high chance of a steady increase in price.
The only danger is the probability of taxation on oil profits, or profits on those who drive the prices up as happened last year. However, there is little anyone can do to prevent Opec or the big oil producing countries choing supply and retaining their profits. In fact, leaders of producers such as Venezuela, Iran or Russia have more incentive to drive the prices back up as the price per barrel not only makes them more wealthy but also more politically powerful.

Not pretty. Not good for mankind, but a great way to even just protect yourself against te cost of higher gasoline prices.

May 08 03:42 PM

[urbanhiker:]

I have held OIL for 4 months, naively thinking it would appreciate along with the price of oil. Wrong! As the rollover occurs to the next month in a contango, you lose money even if the price of oil is increasing. The chart of this ETF bears me out.

May 08 06:49 PM

[sickofthehype:]

Suncor. Bought it in January and look at it now. Enough said. Commodities will skyrocket like they've already started to in oil.

May 08 08:18 PM

[Chris Uhlir:]

Thank you for providing such great answers.

Whippet, could I read more in your personal SA blog on your recommendations for trading software and your data feed source and costs?? Trying to get started surfing these waves!


On May 08 02:35 PM Whippet wrote:

> Look at the LEAPS bull call spreads on liquid optionable securities
> for some interesting high risk/reward plays. I like Jan 2011 spreads
> on USO (35/45 costs 2.85 today and returns a max of 7.15 (250% profit)
> if USO climbs 35% in 17 months). You can tweak these to your level
> of bullishness. I've made a 100% return on a similar play opened
> 3 months ago already. You can also buy ATM or ITM LEAPS and sell
> near month, higher strike calls to pay for time decay and lower your
> basis. You obviously forsake dividends with this strategy and it
> doesn't work well on some tickers.

May 08 10:44 PM

[Chris Uhlir:]

UH,
Ditto me for DXD I mentioned in the article. Feels like another sucker's bet manipulated by Wall Street again a-la Fed/GS. And these guys think they can hide it. The nerve.


On May 08 06:49 PM urbanhiker wrote:

> I have held OIL for 4 months, naively thinking it would appreciate
> along with the price of oil. Wrong! As the rollover occurs to the
> next month in a contango, you lose money even if the price of oil
> is increasing. The chart of this ETF bears me out.

May 08 10:46 PM

[Chris Uhlir:]

UP, Care to elaborate anymore on how higher cost producers will be more profitable?

On May 08 10:44 AM Uncle Pie wrote:

> if you think the price of a commodity is going to rise, the most
> earnings leverage will be found in the high-cost producers, contrary
> to what you might think. In the case of oil, we are talking the
> producers in the Canadian oil sands. The pure play here is Canadian
> Oil Sands trust (seekingalpha.com/symbo...).

May 08 10:48 PM

[Homer II:]

I play the energy arena with a small basket of issues:

COP - most undervalued of the big integrateds
IEZ - oil service ETF owns drillers, suppliers and well service outfits
FRO - owns mostly tankers, large and small
EWZ - Brazil ETF has 30% in Petrobras

May 09 12:38 AM

[Homer II:]

Oops, I forgot one:

EEP - for the dividend, owns tankfarms and pipelines

May 09 12:40 AM

[RiskReturnO...:]

Since the question was about "long term" (>1 year) play on oil and your thesis is that oil price can only go up, the best risk reward trade is buying LEAP (Jan 2011) on EWZ or RSX, which are extremely levered to price of oil.

May 09 11:34 AM

[RiskReturnO...:]

Since the question was about "long term" (>1 year) play on oil and your thesis is that oil price can only go up, the best risk reward trade is buying LEAP (Jan 2011) on EWZ or RSX, which are extremely levered to price of oil.

May 09 11:34 AM

[Sellputs:]

DIG and OIH is you are into trading... FWLT has been beaten down.. was a high flyer.. it split then oil fell off.. but they have massive backlog of inventories for work.

May 09 09:37 PM

[Bobbejaan:]

The oil price rise will be driven by ongoing demand for refined products and hydrocarbon energy in combination with a decline in production. On this basis you need to select either a producer with future reserves or someone who will benefit through providing services to the producers. Refining may not benefit, as there is likely to be enough capacity. For the long run a combination of the following should be good and safe:
- Sasol (SSL): converts coal and gas into oil and gets the value of oil products.
- Integrated oil companies like Total (TOT), ExxonMobil (XOM) or Statoil (STO). The problem here is availability to reserves, some in "unfriendly" places.
- Woodside Petroleum (WPL.AX), an Australian producer of oil and LNG with large investments in the pipeline and with large reserves in safe areas.
- Oil service companies and drillers (SLB, RIG or DO). They do not rely on having oil, but benefit from services when prices rise and searching for oil takes off again.

A balanced approach is better than all eggs in one basket.

May 09 11:57 PM

[Chris Uhlir:]

Did anyone mention passive trust income such as NYSE:BPT. These have no other purpose but to pass along a dividend based on per barrel revenues. Oil spot up, revenues up, dividends up. Anyone care to extend discussion here?

May 11 02:13 AM