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The Ticker – April 2012: Oil prices

I am Brandon Fitzpatrick, equity portfolio manager at DB Fitzpatrick & Co. – a Boise-based registered asset management firm with over $1 billion in assets under management, in both equities and fixed income.   I previously worked as an equity analyst for a boutique firm in Buenos Aires, Argentina.  Most investors have too little international exposure and would benefit from increasing their investment weights in international and emerging market securities.

In today’s podcast I’ll describe what is driving the price of oil, risks that lie ahead, and what investors can do to protect themselves if energy prices rise even higher.

Oil prices are back up after collapsing in 2008. West Texas Intermediate crude is currently trading at $106 per barrel, while Brent crude is up to $125 per barrel.

Oil prices are being driven by both increased global demand and worries about supplies. Demand from Europe and the US is still lethargic as the economies there are struggling, but demand from the emerging economies of Asia and Latin America is still increasing quickly, which is driving an increase in overall global demand.

Meanwhile, there are serious questions about global oil supplies. Much of the world’s oil still comes from the Middle East and flows through the Strait of Hormuz. Iran recently cancelled oil exports to parts of Europe, and the US is encouraging allies to cut off Iranian oil completely in an attempt to coax the country into giving up any possibility of developing nuclear weapons. Military conflict remains a real possibility, as Israel could decide to target Iran’s nuclear facilities on its own.

Iran’s reaction to such an attack is unpredictable — it might decide to attack Israel or US military forces in the region, and could even mine the Persian Gulf. A wider regional war is possible. These dire scenarios don’t have to actually play out for the oil markets to be affected. Their possibility alone in the aftermath of an Israeli strike is likely to cause the price of oil to immediately jump to $150 or even $200 a barrel, which might push the global economy back into recession. No one knows how high oil will spike in such a conflict, and no one knows how such a conflict would play out.

One way investors can protect themselves from an oil supply shock is to buy Treasuries, which are still viewed by the financial markets as safe havens. Treasury yields, however, are very low and probably won’t cover inflation in the coming years so Treasuries should be looked at as an insurance policy – you sacrifice returns for some safety during a disaster.

Stocks in the energy sector are very likely to rise if the price of oil spikes due to a supply shock –equity investors can buy individual stocks in the oil services industry or exploration and production companies. The best option for passive investors and non-professionals would be a diversified energy exchange traded fund, such as ticker VDE from Vanguard or ticker IYE from iShares.

The situation is more complicated if there is no supply shock and increasing demand alone drives oil prices higher. In this scenario the broad equity markets are likely to do well for some time, since they will also benefit from the underlying economic growth driving oil demand. Fast increases in demand, however, could cause oil to spike and might then push the global economy into recession. A weaker economy would then lower demand for oil and energy stocks will fall. This is what happened in 2008.

Please contact me with further questions if you would like me to discuss a particular topic next month. You can follow us on Twitter at DB_Fitzpatrick. My email address is Brandon@dbfitzpatrick.com and my phone number is 208-342-2280.

The Ticker – April 2012 – Click Here to Listen 

About Brandon Fitzpatrick