Pain At The Pump, Profit In The Portfolio

By Aaron Levitt | April 13, 2010 AAA

The strengthening global economy is having an unintended effect: high gasoline prices. The average price of gasoline is up nearly 4 cents over the past three weeks, thanks in part to crude oil's march toward the century mark. The price of Texas tea has been slowly climbing over the past few months, and is now fluctuating within the $70 to $80 range. However, analysts are now predicting that economic recovery in the developed world could add at least $15 to the price of crude.

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A Little Fuel for Thought
Depending on who you listen to, overall global GDP is set to grow in the 4-4.5% range, which is essentially where the planet was in 2007. When the financial meltdown sent the demand for crude oil tumbling, OPEC cut its production levels to maintain operational profits. Non-OPEC members have been struggling with relatively flat oil production for the past 10 years. On top of this, emerging markets over the past year have added nearly 5 million extra barrels a day to their demand. Now that the developing markets - and their emerging market peers - are putting the past turmoil behind them, demand for crude oil will certainly grow, erasing any pre-crisis stockpiles.

Over the next few years, the price of oil should simply move higher on all this increased demand. While exploration and production (E&P) firms can increase production, the lag time in between when that supply hits and demand increases is large enough to cause pump pricing issues. The current average price of a gallon of gas is 80 cents above what is was a year ago and that trend could continue as the heavy driving summer months approach.

Finally, the greenback could be the deciding factor in crude oil demand. While the dollar has been the best house in a bad neighborhood lately, it's likely to remain weak. Because crude is priced in dollars, this weakness should help support the price. A weaker dollar makes crude more attractive to foreign investors.

Profiting from the Pump
With the long-term demand trends in place for crude oil and energy, it makes sense to add exposure to the energy sector. Aside from investing in the energy giants like Exxon Mobil Corp. (NYSE:XOM) or BP (NYSE:BP), investors can also own a wide swath of the energy complex using exchange traded funds.

Nearly 15% of the S&P 500 is in energy stocks and that number is growing as the oil boom restarts. Holding the previously mentioned behemoths, as well as service stocks like Schlumberger (NYSE:SLB), should provide broad exposure, but the Energy Select Sector SPDR (NYSE:XLE) is the most liquid way to add the whole energy sector. Trading nearly 20 million shares daily and costing only 0.21% in expenses, the energy SPDR offers 42 of the largest energy companies trading on the U.S. exchanges. Following an equal weight strategy, the Rydex S&P Equal Weight Energy (NYSE:RYE) spreads its holdings across all sizes of firms, with each holding making up less than 3% of the fund. This type of weighting gives more credence to mid cap energy firms, which should see greater returns to their share prices as oil increases. RYE may make a better choice as this oil cycle ramps up. (For more insight, see ETFs Provide Easy Access To Energy Commodities.)

Going abroad for investors' energy weightings does have benefits. Dividends for international oil corporations such as Italy's Eni (NYSE:E) are much higher than its domestic counterparts. WisdomTree International Energy (NYSE:DKA) offers a 3.09% dividend versus 1.68% yield for the energy SPDR. Foreign energy concerns have also provided greater returns. Since Norway's Statoil's (NYSE:STO) NYSE debut in October 2001, it climbed about 300% through the end of 2009, compared with Exxon Mobil's 80%.

Finally, investors wanting to profit directly from the price of crude or help hedge the pain felt at the pump going forward have two options. The iPath S&P GSCI Crude Oil ETN (NYSE:OIL) and the United States Gasoline ETF (NYSE:UGA), track the price of crude oil and gasoline, respectively. Investors should be aware that the funds can suffer from contango, implying that the outer month contract is more expensive than the front month, making it economically viable for a buyer to purchase the commodity now and store it. This can affect exchange traded products.

Bottom Line
We could be seeing $3 gasoline quite soon. The bullishness in the oil market is being driven by a rosier global economic picture and as the economies of the world continue to grow and pull themselves out of crisis, the demand for crude oil and other commodities will grow right along with it. It makes sense for investors to add a dose of energy stocks to their portfolios; ETFs make that allocation easy. (Learn about factors that affect oil prices in What Determines Oil Prices?)


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