How to Cope With European Uncertainty's Effect on Oil's Realistic Price

 |  Includes: DBO, OIL, USL, USO
by: World Market Pulse

World oil prices remained steady near $84 on Wednesday, as financial markets remained focused on Europe's debt problems even as the American Petroleum Institute report showed that U.S. crude stockpiles (including heating oil and diesel) unexpectedly rose by 224,000 barrels.

There is no doubt that the future of oil prices and related exchange-traded funds is based on the basic fundamentals of supply and demand. With high stockpiles translating into sluggish demand, there would have been a restraining influence on prices -- but the European woes and a cold wave expected later this week are keeping prices resilient.

Crude Oil vs. Financial Factors: Crude oil prices are highly sensitive not only to global political and economic developments, but also to the U.S. dollar, as most of the world's oil sales are denominated in dollars. Usually when the dollar’s value declines, as against the euro, effective costs in dollars increases and so does the pricing of crude. Armed with a positive U.S. consumer confidence data, the dollar has continued its recent renaissance against a basket of currencies. The heightened risk in Eastern Asia is driving a surge in U.S. Treasuries as a safe haven for investors. The U.S. dollar rose broadly after North Korea fired artillery at a South Korean island, sending investors in search of safety and putting geopolitical risk alongside Europe's debt crisis as reasons to play it safe to the year-end.

OPEC president Ecuador's minister for oil policy, Wilson Pastor, has meanwhile said that he expects crude to stay at $75-$85 next year -- a range he called "comfortable" for consumers -- but also signaled a tolerance for higher prices, saying crude could rise to $90 a barrel without endangering the world economy if growth picks up.

Most commentators and oil analysts are convinced that a further rise in prices is inevitable in the next few years as emerging market consumption grows. In the short term, oil is forecast to average $83.66 a barrel in 2011, per a Reuters poll, as analysts revised estimates higher for a second month while cautioning that the upside was limited by euro zone debt woes and possible Chinese interest rate hikes.

While there are uncertainties about the extent and the timing of price changes, oil analyst John Kemp in his column says that long-term projections are little more than educated guesswork and almost certainly underestimate feedback effects on both supply responsiveness and the demand side. Investors and analysts buying 2011-2012 oil futures, or even long-dated 2015-2017 futures to benefit from an eventual tightening in the market, could end up paying a lot of contango in the meantime while they wait for the uncertain prospect of a price spike.

Oil Global Outlook: According to the Oil Market Report released in September 2010 by The International Energy Agency, global oil demand is projected to average 86.6 mb/d in 2010 and 87.9 mb/d in 2011. Readings for 2010 were revised marginally higher, based on stronger data from OECD (Organization for Economic Co-operation and Development) countries. The report also projects global oil demand to grow by more than 25% in the coming 20 years.

For the short-term, investors are better off keeping an eye on market trends, geopolitical risk, and credit issues, while long-term investors should consider the correlation with overall global growth and economic recovery, improved industrialization, and growing oil demand from India and China.

Oil ETFs

United States Oil Fund (NYSEARCA:USO): The investment objective of USO is for changes in percentage terms of the units' net asset value to reflect the changes in percentage terms of the spot price of light, sweet crude oil, as measured by the changes in price of the futures contract on light, sweet crude oil traded on the New York Mercantile Exchange that is the near-month contract to expire, less USO's expenses.

Expense Ratio: 0.80 percent.

United States 12 Month Oil (NYSEARCA:USL):
The investment objective of USL is to have the changes in percentage terms of the units' net asset value reflect the changes in percentage terms of the price of light, sweet crude oil, as measured by the changes in the average of the prices of 12 futures contracts on crude oil traded on the New York Mercantile Exchange

Expense Ratio: 0.86 percent.

PowerShares DB Oil Fund (NYSEARCA:DBO): The Index is a rules-based index composed of futures contracts on light sweet crude oil (WTI) and is intended to reflect the performance of crude oil. You can't invest directly in an index.

Expense Ratio: 0.50 percent.

The iPath S&P GSCI Crude Oil Total Return Index ETN (NYSEARCA:OIL): The index reflects the returns that are potentially available through an unleveraged investment in the West Texas Intermediate (WTI) crude oil futures contract plus the Treasury Bill rate of interest that could be earned on funds committed to the trading of the underlying contracts.

Expense Ratio: 0.75 percent.

Disclosure: No positions.