Why Oil Could be the One Commodity to Defy the Doom…

There’s always some corner of the market that’s making money for investors.

Even in the tough times, when all the ink seems to be in the red, you can still track down a trade with a bit of good old-fashioned detective work.

It may be more challenging than usual in today’s resource sector – but good opportunities still lurk out there.

The first place to start looking is in the energy sector. Even as the small resources index had a horror fall of 63% over the last eighteen months, one of my energy tips, Sundance Energy (SEA), went the other way, letting us lock in a gain of 63%.

But that’s not all. There are plenty more energy opportunities out there too…

Apart from the fact that the world always needs energy, there’s one good reason why energy stocks are doing better than other resource stocks: the price of energy is holding up.

Take the Brent oil price for example. It’s at $107 a barrel today…pretty much exactly where it was two years ago.

Compare that to a commodity index like the Continuous Commodity Index (CCI), which takes in a whole basket of commodities, and is down over 20% in the same timeframe.

The Oil Price – Holding Fairly Steady as Other Commodities Fall

Source: StockCharts

If you look closer at the chart you’ll see the diversion has been very pronounced in the last month.

While oil has shot up 7%, the CCI has fallen 7%.

What’s Going On With Oil?

Well, you can pin most of this on the simmering geopolitical risk in the Middle East.

Egypt has been all over the news as President Morsi was kicked out of the top job. Violent protests have seen scores of people killed. It’s like Groundhog Day as the most populous country in the Arab world spirals into instability again.

The thing is that Egypt is the largest non-OPEC oil producer in Africa and the second largest natural gas producer on the continent. And due to major recent discoveries, natural gas is likely to be the primary growth engine of Egypt’s energy sector.

So the prospect of a drop in production from Egypt due to political chaos is one factor keeping oil prices strong.

But it doesn’t stop there. The Suez Canal and Sumed Pipeline, which both travel through Egypt, are strategic routes for Persian Gulf oil shipments to Europe. Closure of the Suez Canal and Sumed Pipeline would add an estimated 6,000 miles of transit around the continent of Africa.

So when protests broke out right next to the Suez Canal a few days ago, oil prices took another leg up.

Egypt isn’t the only hot spot either. Protests in Libya have shut down several fields there. A pipeline from Iraq to Turkey has mysteriously sprung a leak. And Syria is still a basket case: its oil production keeps falling and has now halved in the last few years.

This tongue-in-cheek ‘map of the world according to investors’ went round the office this morning, simply describing the Middle East as ‘Oil, Drama’! A bit of a simplification maybe, but right now it’s about right…

Middle East: ‘Oil, Drama’

Source: TRB

A bit of fun there, but I wouldn’t laugh too hard. Its summary of Australia as ‘China Echo Bubble’ might not be too far off the mark either!

The ‘drama’ in the Middle East isn’t the only determinant of the oil price of course. With US data going through a better phase for now, the prospect of the world’s biggest oil importer wanting to import more oil has also given the price a kicker in recent weeks.

As well as all this, the simple fact is that it costs more to produce oil today than it used to. There is a natural floor to the price at around $85 / barrel by some estimates.

When oil plunged twelve months ago, it didn’t stay close to that price for long. A price close to production costs would have triggered a drop in production, leading in turn to higher prices.

The reasons being that it’s more expensive to drill oil today as the easy stuff is already gone, and oil companies have to go to ever more inventive and expensive measures to get harder-to-access reservoirs.

We take it for granted, but imagine how hard it would be to drill offshore through five kms of rock from a platform floating a few kms above the ocean floor.

Or how about the costs incurred by the relatively new technique of fracking, which is revolutionising the industry? The infrastructure that goes into ‘fracking’ a well is astonishing.

There is also increasing discussion about the shelf-life of a frack well. It looks increasingly like they expire more rapidly than conventional wells. Because of this, more are needed to sustain flow, and this increases costs further.

Anyway, the point is that thanks to ‘Drama’, stronger demand, and higher production costs, you could expect oil prices to stay stronger than most commodities.

And I’m not overlooking natural gas either, which is a whole other story. Over the last few years it had doubled to break through $4 a few months ago.

So with natural gas doubling, and oil holding its ground, you could do worse than look at energy plays in today’s resource market.

This doesn’t mean that all energy stocks will do well…far from it. ASX-listed energy stocks vary from the great and the good, to the sublime and the ridiculous. Serious homework is required, and a healthy dose of risk appetite is needed on top of that.

But…get it right with energy stocks…and triple digit percentage gains are a realistic prospect.

Dr Alex Cowie+
Editor, Diggers & Drillers

From the Port Phillip Publishing Library

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[Ed note: Continuing for the rest of this week, we’ll publish some of the best recent articles from the guys over at our sibling free e-letter, Markets and Money. As mentioned yesterday, they take a different view on the market.

The Daily Reckoning editors look at the big picture view of the economy and analyse the impact of central bank monetary policy on the value of assets and money. As they see it, these policies have resulted in an almighty asset bubble which will lead to a devastating crash. You’ve read our view; now it’s time to consider the other side. Following is an essay from Greg Canavan, first printed in Markets and Money on 19 June 2013…]

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