Profiting From An Oil Price Spike: A Strategy For Investing In The Middle East

Includes: GAF, GULF, MES
by: Plan B Economics

If you're anything like me, you're worried that escalating crises in the Middle East - particularly Iran - will spiral into some sort of catastrophic event that sends oil prices skyrocketing.

Personally, to mitigate an oil price spike, I already have exposure to a number of energy companies around the world. I don't own any commodity futures based ETFs because I feel that none sufficiently track spot prices, due to the contango issue. However, I wondered if I could profit from an oil spike by also investing in companies domiciled and operating within the Middle East.

I got this idea after listening to an interview with John Burbank of Passport Capital. In the interview he mentioned that one of his funds is heavily invested in Saudi Arabia (a market that remains closed to most investors). In addition to being a fiscally conservative society, Saudi Arabia, Burbank pointed out, would be an obvious beneficiary of an Iranian-induced oil price spike.

No surprise to most, much of the world's proven oil reserves reside in the Middle East, so it doesn't take a giant logical leap to conclude that one can get oil exposure (and perhaps some ancillary diversification benefits) by investing directly in the Middle East. (Note: I specifically wanted to avoid multinationals with branch operations in the Middle East, because these assets are potentially more likely to be expropriated away.)

To determine where in the Middle East one should consider investing, the following table breaks down the 20 countries with the largest proven oil reserves:

Rank Country Proven Oil Reserves (barrels)
1 Saudi Arabia 262,600,000,000
2 Venezuela 211,200,000,000
3 Canada 175,200,000,000
4 Iran 137,000,000,000
5 Iraq 115,000,000,000
6 Kuwait 104,000,000,000
7 United Arab Emirates 97,800,000,000
8 Russia 60,000,000,000
9 Libya 46,420,000,000
10 Nigeria 37,200,000,000
11 Kazakhstan 30,000,000,000
12 Qatar 25,380,000,000
13 United States 20,680,000,000
14 China 14,800,000,000
15 Brazil 12,860,000,000
16 Algeria 12,200,000,000
17 Mexico 10,420,000,000
18 Angola 9,500,000,000
19 Azerbaijan 7,000,000,000
20 Ecuador 6,510,000,000
(Source: CIA World Factbook)

Next, instead of searching for individual cross-listed stocks (or Global Depository Receipts) of Middle Eastern companies, I did a little digging into the few ETFs that provide Middle Eastern equity exposure. I found three ETFs and I've outlined my thoughts on each below.

The largest ETF (in terms of assets under management) with Middle East exposure is the SPDR S&P Emerging Middle East & Africa ETF (NYSEARCA:GAF). Geographically, this fund is highly exposed to South Africa, and not much else:

South Africa: 90.01%
Egypt: 5.65%
Morocco: 4.10%
Australia: 0.25%

(Source: State Street Global Advisors, February 23, 2012)

South Africa only holds about 0.001% of the planet's proven oil reserves, and with 90% of the fund exposed to South African companies I immediately ruled this ETF out.

The next two ETFs I looked at had a more direct exposure to countries with large oil reserves.

Market Vectors Gulf States Index ETF (NYSEARCA:MES) country breakdown:

Kuwait: 37.3%
Qatar: 30.5%
UAE: 21.6%
Bahrain: 4.5%
Oman: 4.3%
Other: 1.8%

(Source: Van Eck Global, January 31, 2012)

Wisdom Tree Middle East Dividend Fund (NASDAQ:GULF) country breakdown:

Qatar: 31.64%
Kuwait: 23.59%
UAE: 19.28%
Morocco: 10.15%
Oman: 5.23%
Jordan: 1.33%

(Source: Wisdom Tree, February 24, 2012)

While both MES and GULF have the appropriate geographic exposure, I found that both only had a 5.6% and 1.7% respective exposure to the Energy sector. For both these ETFs, the sector exposure was 80-90% in Financials, Telecommunications and Industrials.

Despite the low exposure to the energy sector, these ETFs might provide secondary exposure to the Middle East oil industry. Specifically, approximately 50% of GDP in both Kuwait and Qatar is derived from the Oil and Gas industries. 90% and 70% of respective government revenue is derived from the Oil and Gas industries, therefore making energy a critical driver behind fiscal spending. (Source: CIA World Factbook)

I think it is fair to surmise that success for much of the non-energy businesses (and private citizens) in the Middle East originates from oil revenues. Therefore, I think it is reasonable to say that both MES and GULF - with their heavy geographic exposure to businesses domiciled in Middle Eastern countries with large oil reserves - could benefit from the ancillary effects of rising oil revenues.

Accessing exposure to oil prices by investing in the Middle East introduces a new set of risks (e.g. political, currency, transparency) that may not exist in your portfolio. While I would not suggest using MES or GULF to replace one's existing energy exposure, I do think the energy 'sleeve' of a portfolio could be enhanced by introducing these alternative energy exposures.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This is not advice. While Plan B Economics makes every effort to provide high quality information, the information is not guaranteed to be accurate and should not be relied on. Investing involves risk and you could lose all your money. Consult a professional advisor before making any investing decisions.