Oil is dirt cheap and going higher – here’s the best ways to invest

After its crash earlier this year oil is still extraordinarily cheap. But supply is short and demand is only going to rise, says Dominic Frisby. Here, he picks the best ways to invest in oil.

I’ve been buying oil and oil stocks this past week. My simple reason is this: it looks like it wants to go higher. Now let me give you the whats, the whys and the wherefores.

Oil’s story this year – and we’ll use West Texas Intermediate (WTI) as the benchmark – has been that it was trading quite happily in the $50-$65 per barrel range for a good year. Then Covid-19 came along, and it collapsed. That collapse was like nothing I’ve ever seen before. Such was the excess of supply, there was not enough room to store it. As a result, futures went negative, while in April the spot price went to just $6. Extraordinary.

Then came the rebound which took us to around $43 by August, and then we went in a gradual decline until about three weeks ago. What is it that happened then, I wonder? Since then the market has turned up. On November 1, the price was $33. Yesterday, it touched $45. It’s just broken out to new highs. What do new highs normally lead to? Altogether now – “more new highs”! On a short and intermediate-term basis, it is in an uptrend – you know what I think about trends – and it has broken above its one-year moving average, which has now flattened out.

Oil is now cheaper than at almost any other period

If you look at the oil price relative to gold or stocks, oil is extraordinarily cheap. Sure, it’s not as cheap as it was in April – but, this year aside, versus the S&P 500, the only time it has ever been this cheap was in 1999, when oil was at $10. That marked the start of a bull market during which, from low to high, oil went up 15-fold.

If you look at the relative value of oil against gold, it’s at similar multi-year extremes. The same goes for oil against US bonds, UK real estate, bitcoin and just about any other asset class you care to mention. When I factor in the extraordinary money supply growth, stimulus, low interest rates, quantitative easing (QE), lending, bail-out money – whatever words you want to use to describe the money printing that is going on – my view that oil is cheap becomes even more entrenched.

Supply, thanks to Covid-19, is running short, while now, whatever form the recovery takes, oil demand is set to rise. If there’s a huge infrastructure spend: oil. If people start travelling again: oil. If there is a green new deal – believe it or not: oil. Lots of oil will need to be burnt to build the green energy architecture that so many politicians and others are so set on. All roads lead to oil.

The best ways to invest in oil now

So how am I playing it? I already had Shell (LSE: RDSB) and BHP Billiton (LSE: BHP) in my pension pot. With better risk management, I should probably have sold them earlier in the year, but – not entirely by design – I operate a buy-and-forget policy in my pension and so they survived the cull. I’m glad they did because I may not have bought them back. (Although a miner, by the way, BHP Billiton’s biggest product is oil. It has often proved a much better way of playing the oil price than the first stocks you would think of, BP and Shell.)

Last week I placed a simple spreadbet on the spot price of oil. But don’t spreadbet unless you know what you’re doing – it is very, very easy to lose money.

And I bought SPOG. To give it its full title, that is the iShares Oil & Gas Exploration & Production ETF (LSE: SPOG). This trades on the stock exchange like a normal security and tracks the performance of the S&P Oil & Gas Exploration & Production Index. By buying this exchange traded fund (ETF), you are effectively buying shares in the world’s largest publicly-traded oil and gas exploration and production companies. It saves you having to take on individual company risk. You think oil and gas companies are going to do well, so you buy a basket of them.

Finally, as my spicy topping, I bought a Canadian company – MEG Energy (TSX: MEG). MEG is listed on the Toronto Stock Exchange, so if it is of interest to you, you will need a broker who deals in Canadian stocks. MEG has a market cap of around C$1.2bn. It’s a widely respected and competent oil producer which operates in the oil sands of northern Alberta. It also transports and sells its thermal oil production to refiners throughout North America, even down by the Gulf of Mexico, and internationally. It was supposed to have been taken out earlier this year, but the deal fell through. It seems though that the deal fell through for political reasons (deteriorating Sino-Canadian relations) and had little to do with any shortcomings in MEG.

What excites me about MEG is that it is not a particularly low-cost producer. If a company produces oil at $20 a barrel and the oil price goes from $45 to $50, that producer only increases its profit by 20%. But if a company produces oil at $40 a barrel and the oil price goes from $45 to $50, its profits double. So in a bull market, high-cost producers give you much more torque to the underlying commodity. MEG’s breakeven number is $45 oil, so it is right at the margin. For every US$5 increase in WTI, MEG adds over $100m in cash flow.

High-cost producers give you more downside risk of course, if the oil price falls. MEG already has debts outstanding, but its earliest maturing long-term debt is four years out, which allows plenty of time for the oil price to go up. It’s relatively safe. And as the oil price rises, its free cash flow yield improves dramatically. Capacity increases in July meant that now roughly 85% of its production can reach the US Gulf Coast, where global heavy oil supplies are falling from Mexico and Venezuela, while demand currently continues to rise, especially from China (petrochemicals) and India for (infrastructure and road building).

So that’s how I’m playing all this. Fingers crossed.

Daylight Robbery – How Tax Shaped The Past And Will Change The Future is now out in paperback at Amazon and all good bookstores with the audiobook, read by Dominic, on Audible and elsewhere.

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