Energy is the largest and most important commodity class. Within energy is oil, which is thought of by many to be the king of commodities. It produces 40% of the world's energy needs. In 2011 there was a loss of 1.2 million barrels per day of Libyan oil. This loss of supply, plus other variables, helped push Brent crude over $120 per barrel.

Oil investment is not as simple as world supply and demand, as it is a complex commodity. Brent crude is a blend found in the North Sea. Because it is roughly half of the world's production, it is used as a bench mark for light sweet crude in the east. In the U.S., West Texas Intermediate (WTI) is used. This is not the only blend, however, as other examples are Bakken crude and Louisiana Light Sweet. Each blend has its own pricing, which changes due to how light it is. To determine a light versus heavy crude, its API gravity must be above 37 in the U.S.

The price of oil also changes with demographics. The further the oil is from a refinery, the higher the transport costs which increases the price. Bakken crude is a good example as only one refinery is located in North Dakota, at Mandan. Since pipeline capacity in the area is inadequate at this time and hindered even more by the bottleneck at Cushing, it sells at a poor differential to WTI. More importantly is that Bakken crude is lighter than WTI, which means less complex refining is needed and more gasoline and diesel fuel can be produced. Brent and WTI seem fairly priced at today's levels, given the level of U.S. unemployment, the strong dollar and the slowing growth in Europe and China. I do believe that the U.S. pipeline build out will help to decrease the differential of WTI to Brent. I also believe we will see Bakken crude differentials narrow with respect to WTI. I believe Brent will average $109 per barrel and WTI $93 for the remainder of 2012. Bakken crude should average WTI differentials of $12 to $14 throughout the rest of the year. A way to play the price of Bakken crude going forward would be pure plays like Kodiak (KOG) and Oasis (OAS).

There are several distinct factors to the price of oil that any trader must watch. First, there are production numbers. Keep in mind that the majority of oil production comes from areas with geopolitical concerns. The Middle East, Venezuela and Nigeria are all examples of unstable areas that produce large amounts of oil. Iran's push for nuclear enrichment capabilities has been met with NATO sanctions, and there is no doubt that this could lead to military conflicts if not resolved. Without substantially raising oil prices, Iran's crude sales are down 52%. Increased production in the U.S., Canada and Saudi Arabia in concert with Libya and Iraq has managed to meet this demand. Another big factor is weather. Supply could be disrupted in the Gulf of Mexio by hurricanes. It is important to follow crude supply, as contracts can move significantly on any news. These numbers can be found at the Energy Information Administration website.

Demand is just as important as supply. Much is said about China and its increased crude imports, but the U.S. is still its number one consumer. There are three important factors with respect to oil demand going forward that must be considered. Europe's financial crisis, a double dip recession in the U.S. or a hard landing in China could significantly decrease world demand and push the price of oil lower. It is also important to keep track of imports and exports. A good example is the U.S. In 2010, it produced 9.688 million barrels of oil per day. This was the third highest total for that year. In 2009 it exported only 1.92 million barrels per day, but imported 10.27 million. This gives a better idea of how oil plays a role in in the U.S. economy. A big year for oil will be 2013 as Brent averages $125/barrel. WTI will maintain a $20 differential at $105.

There is another way to play oil through the remainder of the year, and that is through the refiners. Companies like Western Refining have had a great year as WTI sells at a big discount to Brent and Bakken Light at a discount to WTI. Refining and marketing is my number one pick through the end of the year as current differentials should be here through the end of 2013, where pipeline capacity will begin to catch up to supply. U.S. refiners are able to compete on the world market selling refined products cheaper than those from Europe. Look for companies with a good foothold in the mid-continent, such as HollyFrontier (HFC) because the Bakken and Canadian crudes will have the greatest value.

Next: Commodities Outlook For The Remainder Of 2012: Natural Gas »

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