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Black Gold, Texas Tea

November 30, 2010

by Robert Huebscher

Another approach to gaining exposure to oil is through individual stocks.  Charles Maxwell, the Senior Energy Analyst at Weeden & Co., spoke about this approach at the recent Advisor Money Show in Orlando.   Maxwell is squarely in the peak oil camp.

Measuring a company’s proven oil reserves per dollar of its share price is the best guide to selecting securities with the best oil-based value, according to Maxwell.  His top recommendation, based on this ratio, is Cenovus, which is listed on the Toronto and New York exchanges and has approximately six billion barrels of reserves in the Athabasca tar sands.  He also recommended Suncor, which is also a Canadian company, and Lukoil, a Russian company without any government ownership.

Maxwell called these “long-life reserve” companies, which can increase their production year-after-year and take advantage of rising prices.

Either Vodra’s or Maxwell’s approach, however, exposes investors to numerous risk factors other than the pure price of oil.  To hedge with oil, investors need exposure to the pure commodity.

One way to do this is through one of the many oil-based ETFs, such as USO or OIL.  The problems with this approach, though, are well known and well documented.   For the last two years, the oil futures markets have been in “contango” – prices are increasingly higher for contracts with delivery dates further into the future.  As a result, much of investors’ return in futures-based strategies is lost as the current contract is sold and a new one is bought.

Investors can sidestep the contango problem by using a long-dated futures contract.  The December 2019 contract last settled at $91.71/barrel.  As Vodra told me, it is hard to imagine oil not piercing the $92 price level over the next nine years. 

The options market offer yet another way to hedge directly using the price of oil.  Options on oil futures trade on the CME exchange.   One can purchase options with exercise dates two years or sometimes more into the future.  An out-of-the-money call option (with a strike price far above the spot price) can serve as inexpensive insurance against extreme events.

Oil trades at roughly $84/barrel in the spot market.  Unlike gold, no one fears it is in a bubble.  Oil prices are certain to be volatile, as supply and demand are likely to be in a tight equilibrium for the foreseeable future.  If an investor can tolerate this volatility and take a long-term view, based on a belief in peak oil, then increasing his or her exposure to oil is a prudent – and potentially profitable – step to take.