Profit from oil this year – regardless of what happens to prices

The threat of a showdown with Iran is keeping the oil price high for now. But there are plenty of other risks that could drag the price lower. What can investors do? John Stepek explains how to profit whichever way oil moves.

By John Stepek

published 10 January 2012

in Features

What's going to happen to the oil price this year?

It's an important question. High oil prices squeeze consumers and companies by driving up costs. They also push up prices, making it that bit harder for central banks to justify easier monetary policies. If times are already tough, high oil prices only make them tougher.

Falling prices on the other hand, would be good news for consumers. But falling prices would also suggest a drop in demand, which in turn points to a slowing global economy. That'd be bad news for the rest of the commodity sphere too.

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I'll tell you right now it's very hard to say which way it's going to go this year. But the good news is that you can position your portfolio to profit, regardless

The surprising strength of the oil price

Following its 2008/09 crash, the oil price has been consistently strong some might say surprisingly so, given the state of the global economy. But from quantitative easing to unrest in the Middle East, there have been many props for the oil price.

And it's pretty clear what's keeping it up just now. Fresh headlines come out of Iran every day. The country is continuing with its nuclear programme. That has led to sanctions, threats of war, and economic turmoil it's no wonder the markets are jittery. The biggest specific threat to the oil price is that the Strait of Hormuz is shut down. About a fifth of the oil traded globally goes through the Strait, so even a short-term closure would send the price spiking.

We've looked at the prospects for upheaval in the Middle East in the current issue of MoneyWeek magazine (if you would like to become a subscriber, you can claim your first three issues free here). But the long and the short of it is that there's no way of knowing what will happen with Iran. The idea of a full-blown war seems mad.

But you can't completely rule it out. Iran's leaders have to keep a lid on internal dissent, particularly as the economy is in a mess. One of the best ways to do that is to build up an external enemy. There's always the potential for things to spin out of control in these situations. And understandably neither America nor Israel seem to be content with the idea of learning to live with a nuclear-armed Iran. So compromise can only take things so far.

Oil prices could also fall hard

On the other side of the equation, there are plenty of downside risks to the oil price. Indeed, Jeffrey Currie of Goldman Sachs reckons the situation in Iran could actually be bearish for oil prices. Why? Because if there's a threat to Iranian supplies, then Europe will start securing more oil from Saudi Arabia. Meanwhile, China would take the excess Iranian oil. Overall, supply would actually increase, not decrease.

On top of this, the investment world seems to be in its usual state of denial about China. The original mainstream position was that "there will be no landing, soft or hard China will just keep growing. It has to".

Now that it's clear that the Chinese economy is slowing, the position seems to be: "OK, there may be a slowdown. But that just makes it all the more likely that the authorities will launch another bout of stimulus. And that'd be great for stocks".

In other words, it's the old bad news is good news' story. The worse the data gets, the more money China's government will pump back into the global economy, and it'll be off to the races again.

However, this might be over-optimistic. The Chinese saw what happened the last time they pumped a load of money into the economy. They've just spent the past year trying to deal with the consequences of that. It seems unlikely that we'd see a repeat of the 2008 mega-stimulus.

So while industrial commodity prices and miners fell hard last year, the threat of a sharp slowdown, let alone a crash, in China, is nowhere near priced in.

What this means for your money

In short, we don't know what's going to happen to the oil price. But there is one thing we can say for sure about the Iranian situation. It makes the disadvantages of relying on the Middle East for energy very clear. This is nothing we didn't already know, but it gives added impetus to efforts to find alternatives.

So investing in North American energy producers in particular could be one way to profit. As US financial analyst Gary Shilling says, "we remain fans of conventional North American energy because of the national resolve to reduce imports from unreliable foreign sources".

We looked at various ways to profit from the US shale revolution' back in October, but there's more to it than just natural gas. We'll be revisiting the topic in MoneyWeek soon.

For a more conservative play, you might want to look at something at a completely different end of the scale. If commodity prices fall, one set of companies that should do well are those that produce staple consumer goods things consumers need, rather than want, like toothpaste. Lower commodity prices mean lower raw material costs. All else being equal, that means improved profit margins.

However, even if raw material prices don't fall, these companies should still thrive because their goods are not discretionary. One attractive option is Procter & Gamble (NYSE: PG). The consumer goods giant is a dividend aristocrat': it has hiked its dividend for more than 50 years in a row. It's currently yielding around 3.2%, better than the S&P 500's 2.1%, and looks worth adding to your portfolio.

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.