Long on Oil

I am not an insider, but there are many insiders are telling me to lock-in oil. They say the world’s best investors are betting billions on oil. Since January this year, they have pumped an astonishing $3.8 billion into oil and gas funds – 171% increase from last year.

OPEC members are scaling back on production. Global recession has frightened OPEC member nations, who were hit hard when oil prices collapsed last fall. They have cut production by 4.2 million barrels a day and even Venezuela and Iran, who often ignore OPEC recommendations, are sticking to their quotas. Compounding the decline in production, OPEC nations are also putting new drilling projects on hold. IEA expects a 21% drop in oil and gas investment budgets in 2009. Although there are recent reports said that there is a glut of oil supply, but smart investors know that the long term outlook isn’t so fruitful. And because it takes a big increase in price to produce a small change in oil demand, prices will spike as soon as supplies tighten.

The IEA predicts global demand will rebound next year with bulk of demand coming from emerging economies. Leading the charge is China, which has been using low commodity prices to stock up on their oil reserves and they are not planning to stop anytime soon. By hoarding oil, China is doing exactly what the rest of the world’s best investors are doing – buying now before oil prices surge.

It cannot be denied that the Fed’s expansive monetary policy and the stimulus package rolled out earlier this year are doubling the money supply, which will raise some inflationary concerns. Precisely for this reason that oil is priced in US dollars, any decline in the value of the dollar makes oil relatively more expensive.

Morgan Stanley’s head of commodities research Hussien says the bet in the long term is one way and that is just up. Deutsche Bank’s chief energy economist Adam predicts oil will be at $100 in 2015 and it could happen faster if the economy recovers while Goldman Sachs raised its 2009 oil price forecast to $85 a barrel and says prices would reach $95 a barrel in 2010.

Having said that, I believe volatility will continue in short term.