Oil looks vulnerable - here's how to profit from a fall in prices

Beyond the turmoil in the Middle East, the picture for oil prices is looking decidedly wobbly this year.

Oil consumption fell during the fourth quarter of 2011, for the first time since 2009, according to the International Energy Agency. And the IEA reckons it's possible that demand won't grow at all next year.

Are they right? And what would this mean for oil prices?

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The turmoil in the Middle East is always a factor in the oil market

You can't talk about oil without mentioning the Middle East. The big, obvious threat to oil this year is the ongoing sabre-rattling over Iran. The IEA acknowledges this in its latest report.

No point beating about the bush: I don't have a hotline to the worlds' leaders, so I can't tell you whether or not this is all going to end in tears. As I noted last week, it seems mad to go to war. But then, it usually does. And it's also hard to see a way to compromise over the issue of a nuclear-armed Iran.

So you've got that ticking along in the background. But against that, you have to remember that geopolitics is always a factor in the oil market. And most of the time, any such disruptions are temporary.

As for the idea that the Saudis want to keep oil at $100 a barrel: as Reuters' John Kemp points out, it's more likely that oil minister Ali al-Naimi (who mentioned the figure) actually saw this as a ceiling on prices, not a floor.

For a start, he was speaking when oil was above $100 a barrel. And in the same speech, he talks of how easy it would be to increase supply rapidly if needed hinting, in other words, that they could make prices fall, not threatening to push them higher.

The Saudis may be happy with a generally higher oil price. But the last thing they want is a price spike that sends the global economy back into recession.

Meanwhile, the fundamentals don't look too healthy for oil. The IEA reckons that oil demand in the US is likely to fall to a 15-year low of below 19 million barrels a day. In fact, according to the US's own Energy Information Administration, US demand peaked in 2005, at 20.8 million barrels a day.

Now, Americans might start using more oil if petrol (gasoline') prices fall. But chances are that after several years of having to cope with high prices, they've changed their habits for good.

The IEA also thinks that demand from China will grow a touch more slowly than it first estimated, as the economy slows. A harder landing for China which is what we suspect will happen could see demand slow even further.

So on balance, we suspect that oil is more likely to fall than to rise from here.

If you fancy betting on the oil price falling, you can do it with spread betting. But that's all about timing your fundamental view might be correct, but you can easily get kicked out of a trade and lose all your money on the swings in the meantime. If you want to learn more about how to look for turning points in markets, you should sign up for our free email, MoneyWeek Trader.

For a slightly longer-term horizon (weeks and months rather than hours and days) you might want to look at an exchange-traded product. The ETFS Short WTI Crude Oil (LSE: SOIL), for example, rises as the oil price falls. And there are several other ETFs you can consider.

It's always a good idea to understand how these exchange-traded products work before you invest in them, and you should check their performance regularly they are not buy and hold investments, and this is a risky and potentially volatile market to trade. But it's probably the simplest way for a retail investor to actively profit from falling oil prices.

Why inflation will remain stubborn in Britain

Won't this be great news for Britain? Well, sort of. Lower energy prices are likely to push inflation lower, yes.

But what bothers me about the UK, is that we have a central bank which has been spectacularly successful at encouraging inflation. If Japan ever wants to solve its deflation problem, the head of the Bank of Japan just needs replacing with Mervyn King. The Fed's Ben Bernanke must secretly be in awe of the man.

The lower inflation goes, the easier it is for the Bank of England to justify printing more money. That might keep a cap on gilt yields although anything approaching a solution to the European crisis might put a stop to those safe haven flows but it would be bad news for sterling.

So while lower oil and commodity prices generally could be very good news for hard-pressed consumers and also many businesses, I'm not convinced we'll see as much benefit in the UK as we might hope.

The US economy is likely to be a bigger beneficiary, assuming it can stay off the quantitative easing ahead of the election. The experts at our most recent Roundtable reckoned that the US is one of the bright spots for 2012. We'll be publishing their top tips in next week's issue of MoneyWeek magazine (out next Friday). If you're not already a subscriber, subscribe to MoneyWeek magazine.

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