How to play rising oil prices

Oil prices are flirting with the $100-a-barrel mark. And they're likely to head higher from here. Tim Bennett explains how to play rising oil prices via spread betting.

"Oil prices are entering a dangerous zone for the global economy," says Fatih Birol, the International Energy Authority (IEA) chief economist in the FT.

Indeed, over the past year oil import costs for the 34 countries that make up the OECD have soared by $200bn to $790bn, says the IEA.

Although they have dropped in recent days on speculation that OPEC may increase supplies, and hopes that US stockpiles are higher than expected, oil prices have been testing $100 a barrel. Brent Crude hit $95 for the first time in 27 months at the start of the month, and the March contract on the ISE futures exchange was still hovering around $96 this morning.

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Sure, prices are still a long way off the heady high of $147 a barrel they hit in 2008, but they are still a long way over the $40 seen towards the end of that year as the world slid into recession.

And while Western economies may still be stuck in low growth the UK's latest 0.5% fall in GDP was the most recent evidence of that as Daniel Knowles notes in City AM "the Chinese dragon continues to eat up fuel". Demand in December hit another record high of 9.618m barrels a day, which represents an annualised increase of 19.9%.

That, coupled with rising US demand as the world's biggest economy emerges from recession, will see "a structural bull market return to the oil market" says David Greely at Goldman Sachs. That in turn suggests "substantially higher prices".

So how to play oil prices? The most obvious route is via a spread bet on the oil price itself. Or you could bet on the price of a major oil firm such as BP, which has seen its share prices take a battering after the Deepwater Horizon spill.

A third option is to use a pairs trade to play the gap between say Brent crude and US crude. At around $9, its "the widest the gap has been since February 2009", notes Will Hedden at IG index.

To profit from a fall in that spread you would need to short Brent crude (trading at around $96 on the ICE) and go long US crude in New York (trading at around $87 on NYMEX). Should the gap narrow, you will make money when you close out both trades.

Watch out though get the trade wrong and you face two sets of losses rather than one. So only try a pairs trade if you are already experienced and consider limiting the damage with stop losses.

Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.

He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.