For energy traders, or any investor simply looking to profit from the oil sector, the question of the day is: “Where are oil prices headed next year?” That’s a loaded question if I’ve ever heard one.
To answer it, we need to have some notion not only about what the U.S. economy will look like, but also what global shakeups will arise 2012. Will Europe, with all its woes, fall into deep recession? How will new international sanctions on Iran affect the world’s supplies?
Well, I was taught at an early age that you never answer a question with a question. So, let’s take a look at what we know — and how we don’t necessarily need the answers to life’s most intriguing questions to profit from the energy sector.
The U.S. Economy
Signs of real strength in the U.S. economy have been popping up in the second half of 2011, but whether that will carry over to the new year, depends on who you ask. Despite what you think of the National Association of Realtors (NAR) and its admittance of a 14% overcount of home sales reported since 2007, its latest data, along with some other housing statistics, do point to a bottom on the horizon.
Recent holiday retail sales data also indicate consumers are still willing to spend when given a purpose. New unemployment claims have fallen to levels not seen since 2008, and an improving labor picture can only aid a recovery and demand for oil.
What day is it? Because that’ll go a long way in determining where the current sentiment on the euro zone crisis lies. It’s almost a foregone conclusion that Italy won’t end 2012 as a member of the European Union. We know the end game, and the daily headlines are simply tiny steps along the way.
Watching the euro-melodrama is like watching those romantic comedies where you know the guy ends up with the girl, but you never know how he’ll arrive at that point.
The European Central Bank is pulling out all stops to keep the euro zone’s financial markets liquid. Witness its recent lending of a record $645 billion to 523 banks at the average of its benchmark rate, currently 1%.
The severity Europe’s inevitable slowdown will hit not only global oil demand. It’ll also have a major impact on the U.S. economy, and one result could be less domestic demand for energy as well.
Despite the turmoil in Europe and the uncertainty over where China’s economy will land, the International Energy Agency is predicting global oil demand will rise 1.4% on the strength of countries like India. Does anyone else see the inherent flaw in relying on emerging markets to save the day?
With 2012 being an election year, it’s no secret the current administration would enjoy nothing more than to have sub-$85 oil prices — and the accompanying reduction in gasoline prices — to tout on the campaign trail. Which is why the recent decision by Congress and the EU to place sanctions on Iran in an attempt to curb its nuclear weapons program were initially met with lukewarm interest by the president.
State Department spokeswoman Victoria Nuland said U.S. officials were looking at how to implement the sanctions in a way that “maximizes the pressure on Iran while causing minimum disruption for friends and allies of the U.S.”
Good luck with that strategy.
Ideally, other countries would increase oil production to offset any decline from Iran. However, the best candidate for that, Saudi Arabia, has shown no signs it’s prepared to boost output.
Just so we’re clear, successful sanctions will in all likelihood result in lower global supplies and higher prices. Talk about a lose-lose situation.
Where Do We Go From Here?
One thing we know for certain about 2012 is that it’s full of uncertainty. But that’s nothing new. We just traded our way through a 2011 that was as uncertain as any year in recent history.
Still, no matter what the headlines are next year, outside of a severe global contagion from Europe, I would expect oil prices to continue the trend they’ve been on the past couple years. This year will mark the third in a row that the average price of crude oil has risen. An average price hovering around current levels ($100 or so) for 2012 won’t be surprising.
So How Do We Profit?
Simple as it sounds, banking on slightly elevated oil prices in an uncertain global economy is what we’re facing. Given that this is what we experienced in 2011, there’s no need to reinvent the wheel. The safe bet would be an exchange-traded fund that tracks oil or the large conglomerates like ExxonMobil (NYSE:XOM) or Chevron (NYSE:CVX), both of which are poised to finish the year with 15% returns.
But for my money, another oil conglomerate that’s been beaten up provides better risk-reward potential. Not to mention it’s headquartered and operates out of a part of the world where energy demand continues to remain robust, rising every year since 2004. That country is Brazil, and the company is Petrobras (NYSE:PBR).
As of today, the stock is down over 30% on the year. It’s stumbled in recent times as a result of some changes in its capital structure to help quickly fund expansion and exploration of new discoveries. Petrobas discovered three new significant offshore oil fields in the past few years, including Tupi, the largest new find since 2000. However, this has resulted in spending that exceeds cash flows.
Engineers with Petrobras estimate Brazil is sitting on over 12 billion barrels of oil, and because of Petrobras’s recent stumbles, the stock is cheap — trading at just 7.4 times future earnings. While oil prices will certainly have an affect on Petrobras’s profitability, it has a few more strengths than a lot of its peers do.
As of this writing, James Mack doesn’t own any of the stocks mentioned here.