Investing in Oil Prices, Not Companies

Saturday, I provided some thoughts with regard to the Saudi Oil Conference. Robert F. Worth and Jad Mouawad wrote an excellent article At Oil Conference, Saudis Offer Slight Rise in Production (free registration is required) for The New York Times. I will just offer a teaser quote and encourage you to read the article in full.

 

Some analysts and oil traders had expected a much larger production increase from Saudi Arabia, the world’s top oil exporter.

But King Abdullah and the British prime minister, Gordon Brown, who walked into the high-ceilinged hall together as a military band played, soon offered totally different perspectives on the problem and how to approach it.

The king spoke of the “selfish interests” of speculators as a main reason oil prices have risen 40 percent this year, urging the gathered ministers to “rule out biased rumors and to reach the real causes for the increase in price.”

But Mr. Brown squarely pointed to fundamental economics and “oil demand rising faster than supply.” The U.S. Energy secretary, Samuel W. Bodman, put it more bluntly in a meeting with reporters, saying “there is no evidence we can find that speculators are driving futures prices.”

 

I am firmly in the camp of not blaming the speculators and instead blaming fundamentals. The demand is outstripping supply. Until either we reduce our consumption or we find more oil, prices will continue to remain high.

For those considering investing in oil companies, you might wish to consider investing in oil futures or an ETF such as U.S. Oil Fund (USO). Often companies will have other challenges such as increased royalty and taxes as oil prices rise. Companies will often face increased costs and have difficulty replenishing their reserves. But with futures or an ETF that mimics oil prices, you can focus solely on oil prices and not have to worry about company specific issues.

 

Comments

[fxtrader07]

'prices will remain high' - yes, most likely.
if they remain high - you will make zero money owning USO or crude futures. you will profit zero from peak oil.
great idea!

'Often companies will have other challenges such as increased royalty and taxes as oil prices rise. Companies will often face increased costs and have difficulty replenishing their reserves.'
that equals a lot of chances, mind you? you simply invest into cheap oil in the ground rather than buying the expensive oil that is being sold to the lemmings today. Buying good oil companies like COP or TOT or XOM means buying oil wholesale. Buying USO means you pay retail prices. Wow, great deal!
Owning producers of rare stuff that goes up in price ios smart in most cases. owning the stuff itself in the pure hope it will rise further - well, might pay off or might be dead money.

Consider thise: If oil (USO) stays flat for the next five years, at an average, the oil majors will make a ton of money. You will have made - ehm, zero.

What do you think, how high will oil go over the next 5 years? 200$? 300$? that would be just a 50%-130% What do you think will that mean to the profits of oil companies and their stock prices and dividends??
At 130$ crude many oil companies are pretty darn cheap and undervalued. of course, crude may fall in price. but then again, your investment in USO will not look so good either. while the oil majors still will make a ton of money. just a slightly smaller ton

[Kevin Stecyk]

Here's a Yahoo chart of USO, TOT, COP, XOM for the past year:

tinyurl.com/59txhg

[fxtrader07]

btw: 'investing in oil prices' is a contradiction in itself. you can invest in companies, in collectibles, in your own business or education. but investing in prices is, well, a priceless misunderstanding of the term 'investing'

[Kevin Stecyk]

I see no contradiction. Whatever.

[fxtrader07]

@Kevin: I know this chart very well (though a longer time frame gives a better picture). It is absolutely underpinning my point: oil stocks have risen far less than they deserved given the price increase of crude oil. the reason is that most stock market participants still don't view the high oil prices as permanent but rather as a cyclical phenomenon. hence, they price the oil majors as if crude is going to 100$ and below again over the coming few months (which it may though i doubt it will)
you will not make a dime extrapolating this past trend into the future. because if oil climbs further, oil stocks will rise much faster when all the investors out there slowly abondon their 'cyclical' views about the high oil prices. You can do very simple math as to how much $/bl of oil will mean how much in additional profits for the majors (which are by anmd large unhedged with their production). And how much of a stock price increase (and dividend raising) that will translate into (e.g. assuming for istance that P/Es stay roughly constant or slightly fall)
I am building significant positions here long COp and XOM and APC - and simultaneously short USO.it's almost a no-brainer over the coming 1-4 years. the only real threat would be additional (and absolutely dumb) govt. 'windfall' taxes. in that case, one would have to rethink the investment. (though stocks like COP even then are good value)

[Kevin Stecyk]

Actually, there are several threats to owning companies. One, ability to replenish reserves. Two, increased royalties. Three, more hostile governments around the globe. Four, carbon taxes levied against oil companies. Five, windfall tax, which you mentioned. Six, poor management. And I am sure that there are more.

If oil prices spike to $200 or even $250, you'll see a nice rise in USO. I am not so sure about the stocks you mentioned.

And if prices do rise to $250, I doubt prices will be sustained immediately. That is, oil prices might spike to $250 and then fall back as the world adjusts. From there, who knows.

If you read my article *carefully,* I did not advocate against oil companies. I own shares in several myself. What I did say was to *consider* owning USO.

[Michael Levy]

10 Reasons Why Oil Price Speculation Requires a Change in the Rule of Law by Michael Levy

High oil prices that are governed by the commodity markets are in dire need of common sense law and order. When speculation and detrimental logic and reasoning take central command of human society, the results always turn out to be damaging to the majority, at the abundance of the few. The experts and speculators will argue we need free markets and any interference will take away free trade. Well, in many cases they are correct, however, when it comes to essential commodities of food and energy they are completely out of order. Here are a few reasons why essential commodity markets require new legislation.

1. There has been no shortage of gas at any filling station for the past 10 years yet prices are up 1200% because of futures trading going out more than eight years. Even the Saudi oil minister has recently stated the price of a barrel of oil should be no more than $70.00. Demand from China and India is still far less than that of the USA. The Chinese stock market is down 50% signifying a sharp slow down. This news still is not enough to stop the wild speculators hiking the oil prices.

2. When hurricanes hit Florida many gas stations are closed and there is a real shortage of gas for a few days. However, if a gas station increases its prices they will be prosecuted for price gauging. Therefore, if we take the experts argument that there is a shortage of oil then that still does not give anyone the right to profit from the shortage as this is deemed to be prices gauging. How can the USA governments have double standards and prosecute gas station owners who price gauge and not treat commodity markets in the same manner?

3. Oil is an essential commodity for every day living in the same way as water is an essential commodity. It makes no sense to trade water so why leave oil in the hands of anyone who wants to make a quick buck gambling on prices.

4. Pension and hedge fund managers have invested billions of dollars in oil futures. The futures markets are very volatile, thus, no place for pension funds to risk the money for people who trust them to build future wealth. The fiduciary duty of a pension fund manger is to find reasonable returns with low risk and the commodity markets is not that place.

5. If the price of oil was regulated between $40.00 - $80.00 a barrel, the price could go up and down on supply and demand. This would be fair to everyone, for even when supply was plentiful, the price would not drop below $40.00 which will still give a fair profit to most oil related industries. When oil is in short supply the price would be limited to a ceiling of $80.00 which is more acceptable to world economies.

6. There is a moral issue that greed cannot come before peoples basic needs ... No right-minded, ethical, principled government can allow starvation and financial ruin because of a system of trading that is completely out of control.

7. The price of a barrel of oil effects transport, food supply, industrial production and every part of modern day living. If terrorists wanted to devise a plan to destroy the world. economies what better way than finding a method to allow oil to trade at $140.00 a barrel. Why play a game that makes terrorists and anarchists happy.

8. Goodwill to all people is the credo every democratic country is built upon.$140.00 a barrel oil delivers no goodwill. It only brings hardship and political uneasiness.


9. Noble deeds and fair dealing is the hallmark of success for every truly prosperous person. Since the world is made-up from people, where are the noble deeds and fair dealing in the commodity pits.

10. We are all put on earth to help each other succeed in the pursuit of freedom, liberty and happiness. There is no freedom when people are slaves to greed. There are only liberty takers when oil trades over $80.00 a barrel. And finally financial hardship brings misery and discontent.

The time for change in essential commodity trading is now. To quote a few voices from the past...

“Experience demands that man is the only animal which devours his own kind, for I can apply no milder term to the general prey of the rich on the poor”_Thomas Jefferson

“For greed all nature is too little.”_Seneca

“It is greed to do all the talking but not to want to listen at all” _ Democritus

“He who is greedy is always in want.” _Horace

[fxtrader07]

@kevin: i get your point but then you simply speculate (not invest) on significantly higher oil prices to materialize (which may happen or may not). and yes, all the govt interference you mentioned would probably lead to exactly those - since each and every discourages oil producers from finding and producing more oil (in fact, it pays them to leave the oil where it is until some one more educated in economics governs the country)
however, if things simply stayed as they are right now, then oil stocks will be by far the superior deal for the coming years as compared to crude prices

[TBill]

I fail to see how XOM can be considered an investment in oil. It has to buy 95% of its oil.
USO has demonstrated it lacks to ability to keep up with the price of oil. I've heard it is because it has to roll its futures contracts during a window, and the locals front run. And then there is the management fee. What we need is a good oil tracking stock.
[I see Levy has been busy posting/copying his propaganda around at various threads. A man with a cause.]

[Investor612]

No doubt Mr. Levy realizes that the same argument he makes for regulating oil prices could be made to a number of commodities and products, from corn to wheat to steel to copper and so on. The problem with taking over markets by the self-anointed "enlightened"... is that history has proven such socialism to be inferior to free markets when it comes to producing more of desired products at lower prices. Yet some continue to embrace the notion that government control really can do it better. Go figure.

[nakedjaybird]

nakedjaybirdJun 23 02:07 PMWhere have some of you folks been? In "school" maybe???

In the early 1970's we concluded it was going to take hybrid electric vehicles for anything beyond the basic 40-50 mile daily commuter using fully electric cars, when and if he was ready to switch from huge gas guzzlers (we knew this because we built and tested electric vehicles! And, there is a market for both types of vehicles). The shackles have been off for the private sector for 40 years.

We were also growing silicon ribbon and producing solar volataic panels in the 70's. The shackles have been off for the private sector for 40 years.

We have used windmills for long before many of you folks existed. Seems like we know how to make and use all of the components. The shackles have been off the private sector for a long time.

One of the major problems is the selfish consumer. His shackles have been off - he's had some free choices.

Another major problems is we have permitted our Government give our tax dollars to big oil thru tax breaks (research, investestment credits, depleption allowances, and on and on).

WE HAVE NOT DONE THE RIGHT THINGS;

NOT EVEN THE THINGS WE WERE/ARE CAPABLE OF DOING. BUT........... THAT ..........

Didn't stop France from going 80% nuclear.

Didn't stop Germany from going 40% solar.

Didn't stop Brazil from going 60% biofuel.

Didn't stop Switzerland (and many other European countries) from going electrified rails for people and goods, and even electric ferries (they put rubber tired hiway diesel busses on electrified rail cars for certain legs of their journeys).

Didn't stop Europe from building and using small economical cars, nor electric delivery vehicles, etc.

So where has the US been??

I guarantee you, without LEADERSHIP, we will not get there....................

We have had the techonologies; we've had the money; we've had the resoures; we've had our heads somewhere, like where the sun doesn't shine.

AND FOR THAT, THERE IS JUST TOO MUCH EVIDENCE!!!!!!!!!!!!!!...

[solar jim]

To Michael Levy:

If speculation is the reason oil is going up then at some point people would have to take actual possession of the good and continue to keep taking it off the market and continually reduce the total supply enough to actually raise prices over the amount actually produced by hoarding it somewhere. Please show me where these extra barrels that speculators are buying are being stored - which costs still more capital.

The fact that people don't want to address is that the US dollar has decreased in purchasing power under the Bush administration. As oil is priced in dollars and these other sovereign nations (middle east) want to have the same purchasing power as before the price goes up as a reflection of that fact.

China and India are growing at a very fast pace. The US and other devloped nations can do little to stop the rise in energy costs by raising interet rates so long as China, India, Brazil, etc... keep growing as fast as they currently are. If the major users, and buyers, are these fast groing counties that don't have a problem continuing to buy and push up rates then everyone else gets to join in for higher prices.

If this doesn't make sense then get ready to keep paying ever more over the next decade, or two, and have no idea why prices keep going up.