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How to buy into the oil boom
Oil doesn't have to reach $105 a barrel for individual investors to benefit. The best ways to play the sector may be mutual and exchange-traded funds.
By Robert Walberg
The price of crude oil has jumped more than 30% since the year began, amid tight supply and growing demand from China, India and the United States. There's talk of a "super spike" that could send the price higher. Energy companies are pulling in big bucks, and their stocks are climbing.
All this has investors wondering whether there's still time to strike "bubblin' crude" like Jed Clampett. There is.
Wall Street's earnings estimates for oil companies are based on oil prices that seem almost old-fashioned now. So when the earnings come in, the stocks could rise even higher. The best ways for individuals to make money off the current oil boom include mutual and exchange-traded funds.
The most recent hoopla over oil happened last week, when Goldman Sachs made big headlines after its analytical team boosted its top price target on crude to $105 per barrel, from $80. Goldman noted that "oil markets may have entered the early stages of what we have referred to as a super-spike period, a multiyear trading band of oil prices high enough to meaningfully reduce energy consumption and recreate a spare capacity cushion only after which will lower energy prices return."
Back in the bubble
A move to $105 per barrel would represent a jump of more than 80% from today's historically high levels. It's not exactly Amazon.com (AMZN, news, msgs) at $300 per share, but it's close.
For those of you that don't remember, an Internet analyst boldly predicted that Amazon would hit $300 per share back during the Internet bubble. The stock almost immediately bolted to that level amid a wave of speculative buying. Amazon had yet to earn a penny, and sales were growing quickly but nowhere near levels that would support such a ridiculously high price. It was the advent of the Internet speculation that ultimately ended with the market tumbling down.
Goldman did a much better job of laying out a fundamental case for how and why oil prices could spike sharply higher. It's also important to realize that the firm didn't necessarily predict that crude would go to $105 per barrel, only that conditions are developing that could create a wild, temporary spike higher.
At the root of Goldman's argument is that back in the late '70s and early '80s, "gasoline spending was a much higher percentage of the economy and consumer spending than it is today, likely explaining the lack of impact we have seen thus far from what otherwise appear to be high crude oil and gasoline prices. Our new super-spike range assumes a level of gasoline spending relative to the economy and consumer spending that is still below the heights reached in 1979-1981, suggesting our new range could prove conservative."
For the gas-guzzlers
That's not a misprint folks -- Goldman believes its $105 outside target could prove conservative. That's a little scary, especially if you're like many Americans and drive a gas-guzzling SUV. Of course, Goldman stands alone in this forecast, so maybe we shouldn't worry too much.
Indeed, most analysts on Wall Street still see oil prices stabilizing below $50 per barrel. Then again, most Wall Street analysts have been underestimating crude prices for the better part of two years, so following the herd might not be such a good idea, either.
Oil-related commentary on MSN Money
What should investors do? Energy stocks are up big this year. Seven of the 10 best-performing groups are energy related. Their gains ranging from 13% to 29%. But will the majority of the Street prove correct in its assumption of sub-$50 per barrel oil and, if so, will oil stocks fall?
On the one hand, it doesn't matter too much whether crude prices rise or fall another $5 per barrel. The fact remains that most of the Street's earnings estimates for the oil sector are based on mid-$40 crude, or lower.
That being the case, investors should expect the oil sector to handily beat estimates this earnings season. Additionally, since oil has remained at such a high price for so long, oil companies are likely to paint a pretty optimistic outlook for the balance of the year. Over the intermediate to long term, one thing that almost always bolsters share prices is better-than-expected earnings growth coupled with a bullish outlook.
An unlikely scenario
Obviously, if crude plummets it'll be unlikely that the energy sector will hold its gains. But does anyone really foresee a scenario in which crude prices drop below $45 per barrel? The worldwide economy would have to slip into recession and consumers would have to alter their consumption habits dramatically for that to occur. Basically, the downside risk to oil at this juncture seems limited.
So even if you think Goldman's analytical team is full of malarkey, it's still not too late to participate in the energy sector's biggest up-cycle in several decades. How best to play the rise in crude is another issue.
Buying a stock in the energy sector is the obvious, most-direct way to play the jump in oil prices. ChevronTexaco (CVX, news, msgs) did just this the other day, when it agreed to buy Unocal (UCL, news, msgs) for $16 billion. But buying individual stocks in the energy patch carries with it a relatively high degree of risk because it doesn't provide much diversification. There's little that's more frustrating to an investor than making the right sector call but picking the one or two stocks that grossly underperform.
That doesn't mean that adding a quality, large-cap name like Exxon Mobil (XOM, news, msgs) is a bad idea, especially since it's likely to get plenty of action from portfolio managers desperate to keep up with the sector's performance. It's just that it can be unnecessarily risky to pick one or two stocks from the sector.
Zeroing in with diversification
The use of industry-specific mutual funds is one way investors can increase their exposure to the sector in a more diversified manner. Some of the better-performing funds this year include Profunds UltraSector Oil and Gas (ENPIX), Fidelity Select Energy (FSENX), AIM Energy (FSTEX) and Vanguard Energy Index (VENAX). Investors should check with MSN Money's mutual fund research tools to find the funds' ratings, management fees and historical performances.
Exchange-traded funds, or ETFs, are another option open to small investors looking to participate in the energy rally with some diversification. The best performer and the most actively traded by far is the Energy Select Sector SPDR (XLE, news, msgs). It's up 20% so far this year and has total assets of $1.6 billion. Among its top holdings are Anadarko Petroleum (APC, news, msgs), Apache (APA, news, msgs), Burlington Resources (BR, news, msgs), ChevronTexaco and ConocoPhillips (COP, news, msgs). Other energy-related ETFs include Vanguard Energy VIPERs (VDE, news, msgs), iShares Energy Sector (IYE, news, msgs) and iShares S&P Global Energy Sector (IXC, news, msgs).
Unless you fancy yourself an oil analyst or you have a lot of time to devote to breaking down the numbers of each energy company in the oil and gas, exploration, oil services, oil tanker and alternative energy groups, then you should consider the fund or ETF options. ETFs probably offer the best bang for the buck because their fees tend to be lower and they trade like stocks, making them easier to manage.
Whatever you choose, the only bubble in the oil patch is the type coming up from the ground. So don't hesitate before adding some black gold to your portfolio. If nothing else, you can use your profits in the market to pay the prices at the pump.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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