How to profit from oil's new highs

Thanks to ongoing supply and demand pressures, crude oil approached its all-time high last week. Martin Denholm reveals how to cash in on oil - and its alternatives.

Got deja-vu yet?

This time last year, oil prices were blasting to an all-time high of $78.40 per barrel.

And with Americans hitting the beach, it's happening again. The black stuff is creeping back toward that level.

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Crude prices traded as high as $73.80 today (Thursday 12th July) - up almost $8 in just the last month. Sure, you can blame the Iraq war. You can blame the oil workers' strike in Nigeria. You can curse crazy ol' Hugo Chavez, stirring the pot in Venezuela.

But the main reason is much more simple than that. Supply and demand. And if you think it's bad now, it's only going to get worse...

'Increasing Market Tightness'

In February, the International Energy Agency (IEA), an advisor to 26 industrialized countries, said global oil demand would rise by 2% per year between 2006 and 2011. Not quite. The group had the calculators back out this week, making a 10% upward revision to that estimate, and now calls for a 2.2% demand spike per year between 2007 and 2012. That's an increase from 86.1 million barrels per day (bpd) this year to 95.8 million bpd in 2012.

No wonder oil prices are back in the $70s.

Oh, and if you're hoping that the 12-nation OPEC oil cartel will save the day, don't bank on it. The IEA says that OPEC, which supplies 42% of the world's oil, has overestimated its projection for 40 million bpd day spare capacity in 2009 by 2 million bpd and that spare capacity will shrink 'to minimal levels by 2012.'

In addition to supply-demand pressure, factor in potential price-shocking issues like geopolitical strife, war, terrorist attacks and natural disasters, and you've got a recipe for higher prices. The OPEC oilmen would hardly cry about that. And don't expect much help from non-OPEC nations either. The IEA says oil production has slowed there, too.

Not good news, considering that over the next five years, demand from Asia and the Middle East is expected to surge three times faster than in the 30 industrialized nations of the Organization for Economic Cooperation and Development (OECD).

Can we get some help here? And can we profit? The answer is 'yes.'

Renew And Conquer... The Buzz Is Getting Louder

While folks get all hot and bothered about oil prices rising again, it's sparked a fresh debate and rally in renewable energy resources. Yeah, I know... some people scoff at this, saying it takes too long to develop them and is too expensive. But if it helps wean America off its 'addiction to oil' from the Middle East and also helps the environment, what's not to like?

As technology advances and investment rises, it will become cheaper to develop and sell renewable fuels. And sure, it might take some time. But remember, it took two decades for automakers to convert from leaded gasoline to unleaded fuel before the trend became commonplace. But with more investment and better technology, there's a much harder push for renewable fuels these days, and it's catching on faster. If you don't believe me, just look at what the big boys are doing...

Follow The Smart Money To Smart Profits

In 2006, Microsoft founder Bill Gates pumped millions into Pacific Ethanol (Nasdaq:PEIX) stock, driving the price to almost $27 this time last year. Ethanol itself soared to an all-time high of $3.98 a gallon at the same time, before the hype caught up to the industry and prices slumped 45% to $2.20 today.

But with corn prices having dropped almost 30% from a 10-year high in February, ethanol may have hit the bottom and momentum is starting to build again. And although ethanol only also accounts for 4% of U.S. gasoline supplies, ignore the folks who sneer at that figure. Instead, consider ethanol as a fuel with plenty of room for growth.

For example, ethanol is expected to suck up almost one-third of America's corn crop by 2010 - more than double the consumption one year ago. In addition, the Renewable Fuels Association says refineries will pump nearly seven billion gallons of ethanol to consumers this year - two billion more gallons than a year ago. And now that PEIX shares have fallen to $14, it represents much better investment value.

Virgin Group founder Sir Richard Branson has also invested about $400 million in ethanol and is trying to use it to fuel his Virgin Atlantic airline.

And Vinod Khosla, the financial muscle behind mega-firms Google, Sun Microsystems and Genentech, is pumping millions of his estimated $1 billion fortune into renewable energy, investing in almost 30 companies.

All told, renewable energy pulled in $71 billion worth of investment in 2006, 153% more than the $28 billion in 2004, according to the American Council on Renewable Energy. And the boom is reflected in the investment world, with the rapid growth of renewable energy funds and ETFs...

Why Sit On The Fence When You Can Jump On Both Sides?

Gone are the days when 'green' investments were nothing more than a good way to lose money in a vain attempt to give the planet a hug. There are several good ways to invest in this fast-growing industry.

For example, take a look at the New Alternatives Fund (NALFX) - up 41% over the past year and 25% this year alone which holds Spanish heavyweight energy firm Abengoa. Another option is the Guinness Atkinson Alternative Energy Fund (GAAEX) - up 31% this year. However, the minimum initial investment for both funds is $2,500 and $5,000 respectively, with expense fees tacked on.

So how do you profit from an upward price trend without having to fork out a big initial investment, incur costs, and have little flexibility when it comes to buy/sell decisions?

The answer is exchange-traded funds (ETFs). On the oil side, the Energy Select Sector SPDR (AMEX:XLE), a basket of the biggest oil and oil service companies that includes ExxonMobil, ConocoPhillips, Chevron and Devon Energy. And on the alternative fuel side, the Powershares Wilderhill Clean Energy Fund (AMEX:PBW), a basket of stocks geared towards cleaner, renewable energy. This includes Kyocera, Color Kinetics, Echelon Corp, Cree Inc, Cypress Semiconductor and Sunpower Corp. Because why invest in just one industry when both are performing well?

Today, XLE capitalized on oil's upward march by hitting a new 52-week high of $73.18. That's a 22% rise from $60 on March 22. And with oil rising, PBW followed suit, climbing to a fresh high of $22.58 - a 25% spike from $18 over the same period. This is an important trend - these ETFs often rise and fall together.

Those 52-week highs are bullish, my friend - and both ETFs are a good way to diversify your portfolio and gain exposure to two major rising industries in a cheap, low-risk, efficient and flexible way.

By Martin Denholm, Managing Editor, Mt. Vernon Research for the Smart Profits e-Report,