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The prospect of $200-a-barrel oil used to be unthinkable. But crude's price has already more than doubled in the past year, to $139 in mid June, so another 44% rise is hardly unimaginable. Goldman Sachs analyst Arjun Murti, who accurately forecast triple-digit prices several years ago, says oil will hit $200 a barrel within the next couple of years.
Murti may be right again. Or oil may represent a classic bubble about to burst. Trying to determine short-term price swings is sheer speculation, although you can make a strong case that the long-term trend is up, primarily because of growing demand in emerging markets.
Whatever the next short-term move, it pays to have exposure to oil in your portfolio. Oil stocks or investments that track the price of crude itself provide a double hedge. They help offset rising gasoline prices and other increases in your energy costs. And they can counter the damage done to your other stocks, which lately have shown increasing vulnerability to rising oil prices. Even though oil and other commodity investments can be volatile, they are tamer when combined in a portfolio with stocks and bonds because the risks of each type of investment balance one another to some degree.
Stocks used to be the only avenue for the average individual to invest in energy. But that has changed in recent years with the introduction of exchange-traded funds (and their cousins, exchange-traded notes) that track commodities. Here is a look at some of the best ways to play rising energy prices, both for stock investors and for those who want to ride commodity prices.
Direct bets. When you buy an energy stock, you are betting not only on the price of oil, but also on the quality of the managers who run the company. By investing in oil itself, though, you cut company management out of the equation (for better or worse).
The purest oil investment, short of storing barrels of crude in your garage, is United States Oil, an exchange-traded fund that tracks the price of West Texas Intermediate, the U.S. benchmark grade of crude. The ETF (symbol USO) returned 107% over the past year to June 9, closely mirroring the return of the futures contracts it buys.
But U.S. Oil and other futures-based ETFs come with their own set of quirks. Futures prices sometimes lag the cash-market price (the price you often hear about on the news) because of a condition called contango. When the market is in contango, ETFs such as U.S. Oil must buy the next-month futures contract at a premium price and, when it expires, sell it at the lower cash-market price -- a losing proposition.
Most of the time, oil-futures markets are not in contango. But when they are, a new fund, United States 12 Month Oil (USL), mitigates the problem by tracking the average price of 12 months' worth of futures contracts rather than the next-month contract. For that reason, we give a slight edge to this fund over U.S. Oil. Year-to-date to June 9, 12 Month Oil, which launched last December, returned 40%, compared with 36% for U.S. Oil.
Crude oil, of course, is just one of many energy products. You can find ETFs that track other types of energy, including United States Gasoline (UGA), United States Natural Gas (UNG) and United States Heating Oil (UHN). But prices of these commodities don't necessarily move in lock step with the price of crude oil, and it's hard to get the timing right, in any case. You would be better off simply buying the bunch through the iPath Dow Jones-AIG Energy Index Total Return Sub-Index ETN (JJE). A subset of the Dow Jones-AIG Commodity index, it tracks a collection of energy products, including crude oil, natural gas, heating oil and gasoline. Launched last fall, it has returned 52% year-to-date to June 9.
The iPath fund is an exchange-traded note. Unlike an ETF, which buys the underlying futures contracts, an ETN is a bond that promises to pay a return identical to the futures (plus interest on cash collateral for the contracts). So while the ETF's returns can stray slightly from those of the underlying futures, the ETN's returns will always be spot on with the futures (plus interest and minus the ETN's expenses). ETNs are also taxed at a lower rate than ETFs. On the negative side, the ETN, as a bond, could fall in value if its issuer (in this case, Barclays Bank) runs into financial trouble. In addition, there are signs that Congress and the Internal Revenue Service may eliminate ETNs' tax advantage over ETFs. In general, we like ETFs better, although we don't mind recommending some ETNs when there's no ETF alternative.
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