At times of political unrest – especially in the Middle East – there are two go-to assets…
Gold and oil.
You know the gold story. And you know our view on it. But what about oil?
And in a moment, we’ll show you two ways to make the most out of rising energy prices… without using risky investments such as futures or CFDs. First, just why are we so bullish on the energy story…
The Threat to 5% of the World’s Oil Supply
One reason is this report in the Financial Times:
“The oil market was spooked after an Iranian state-owned broadcaster reported that the country had stopped sales to six European countries. The report was initially denied by the Ministry of Oil in Tehran, which later said it could neither confirm nor deny the news.”
This isn’t the first time Iran has caused a stir in oil markets. In December Iran threatened to block the Strait of Hormuz that leads from the Persian Gulf to the Indian Ocean. That shouldn’t be hard. At its narrowest, the Strait is just 35km wide.
And with Iran producing 5% of the world’s oil, anything that causes Iranian oil production to fall (or even stop) is bound to affect the oil price.
Since last October, West Texas Intermediate Crude Oil (the U.S. benchmark for oil) has jumped from USD$80 to USD$103 per barrel. Middle East tensions are part of the reason.
But political gamesmanship isn’t the only reason we’re backing energy. For a start, oil is becoming harder to find. Last year oil giant, Exxon Mobil said its 10-year average oil reserve-replacement ratio (RRR) was only 95%.
That means for every 100 barrels Exxon pulls from the ground it only finds 95 barrels in new reserves.
In other words, Exxon’s oil reserves are heading south.
On the other hand, its natural gas RRR is going the other way. Its 10-year average gas RRR was 158%. Meaning for every unit of natural gas recovered it added over 1.5 units of new gas discoveries to reserves.
In short, it’s more evidence that natural gas is set to overtake oil as the world’s main energy source. But that doesn’t mean oil prices will fall. The world still relies on oil. And an ongoing shortage plus political tensions could still see oil prices go higher.
What about natural gas? Well, while oil is trading at multi-year highs, natural gas is trading at multi-year lows. That’s what makes it so attractive for investors…
The Worst Commodity for Four Straight Years
At the start of each year, we always look out for the U.S. Global Research Periodic Table of Commodity Returns:
Click here to enlarge
We’ve circled natural gas performance over the past four years. It’s the only commodity in the table to produce a negative return in each of those years.
In fact, right now natural gas prices on the world market are trading at decade lows. They’re back to 2008/09 levels.
Our view is natural gas prices won’t stay low forever. Sure, there’s a glut at the moment. Mainly due to new technology making it easier to recover hard-to-get gas reserves. But at some point the market will do what markets always do: it will find a level where it’s profitable for explorers to extract the gas, but not so high that businesses and entrepreneurs look for other energy sources.
So, how can you make the most of higher oil and natural gas prices?
There are two ways. To get exposure to the oil price, Aussie firm BetaShares has listed an oil exchange traded fund (ETF) on the ASX. It trades with the code OOO. And you can buy it through your broker as you would any other share.
The benefit of ETFs on commodities is that you don’t need to open a futures trading account and nor do you have to trade large (and risky) futures contracts. For instance, an oil contract on the Chicago Mercantile Exchange is for 1,000 barrels. That’s a contract valued at USD$100,000 at today’s prices!
By contrast, the minimum investment on the ASX is just $500. If you want to bet on higher oil prices, without risking the family silver to do it, the OOO makes more sense.
Just be aware of one thing. Without getting too technical, BetaShares hedges its position by trading in futures contracts. So it doesn’t hold physical barrels of oil (which would probably be difficult anyway). But the company does claim the fund is fully backed by cash.
Of course, in order to make a decent return you’ll need the oil price to take off to $150 or even $200 per barrel. So, if you’re after some leverage but still only want to bet small amounts, you’re better off taking a punt on small-cap stocks…
Again, you only have to invest small amounts – as little as $500. But with small-cap stocks you get inbuilt leverage. If you bet on the right stock early, say before it’s found oil or before it increases its reserves, you can see your $500 stake turn into $1,000 or $2,000 in a fairly short time.
And because you’ve only put down a small amount, you know your maximum risk up front (that’s something you’re never sure of with the futures market).
Bottom line: if you’re looking to invest in the best performing sector this year, all the evidence points towards a good year for oil and natural gas prices. And that should mean a good year for oil and natural gas stocks.
Look to add a handful of small-cap oil and natural gas stocks to your portfolio while much of the sector is still cheap.
P.S. We mentioned the gas glut that’s keeping down natural gas prices. One reason for the glut is the exploitation of shale gas reserves in the U.S. Shale gas has become so important that it’s estimated the U.S. will become energy self-sufficient within the next 18 years.
P.P.S. It’s not just in the U.S. that companies are looking for shale gas reserves. It’s happening right here in Australia too. And my old pal, Dan Denning has been on the story from the start, picking three small-cap stocks that are already in the money. If you’d like to take a punt on these stocks, Dan tells us it’s not too late to get in. Click here for details…
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Written by Kris Sayce
Kris Sayce is Editor in Chief of Australia’s biggest circulation daily financial email — Money Morning. (You can subscribe to Money Morning for free here).
Kris is also editor of Australian Small-Cap Investigator, his small-cap stock research service, where he provides detailed analysis on some the brightest, smallest listed companies on the ASX.
If you’re already a subscriber to these publications, or want to follow his financial world view more closely, then we recommend you join Kris on Google+. It’s where he shares investment insight, commentary and ideas that he can’t always fit into his regular Money Morning essays.