For those with nerves of steel – buy oil

Most investors are likely aware that the price of oil has plummeted. This has taken a lot of equities down with it.

This is a very rough statement (some areas are cheaper to mine than others), but it is getting to the point (roughly US$75-ish) where a lot of tight oil (shale) is unprofitable to mine. This is where most of the oil boom from North America has originated. Heavy oil (oil sands) highly depends on where it is mined.

There are geopolitical games being played by OPEC and Saudi Arabia and the rest of the world. Commodities can trade under the marginal cost of extraction for awhile, but not indefinitely – especially in the case of crude oil, there will be demand.

The question is who shuts off the supply first? It will be the most insolvent high-cost producers, and then increasingly the more solvent unprofitable producers until the market supply decreases. Only then will we see oil prices turn around.

I do not believe a downturn in the oil commodity price will be sustainable for a long period of time in light of global demand still being high.

Decreasing capital budgets for 2015 will translate into decreased supply. However, this is not a speedy process. Most tight oil producers require a continual stream of capital to keep production levels stable and so I would guess some time in 2015 you are going to see a very sharp rebound in oil prices once enough supply has been shut off.

There is a cliche that markets go up slowly but crash quickly. With commodities, they go down slowly and rise quickly.

From my 50,000 foot perspective, there seems to be opportunity. I’m going to guess that low prices will persist until the end of this year. I do not see low prices continuing throughout 2015 unless if there is some sort of major global slowdown beyond what we already see in Europe and China (in the latter case, if you can call a decrease from 7% GDP growth to 5% GDP growth a “slowdown” when your GDP is already 9 trillion dollars, then it is a very odd definition of a slowdown!).

Picture yourself as some economic analyst in the People’s Republic of China with a mandate of securing global energy supplies. Right now you’d be licking your lips and looking at the various publicly traded entities out there. Your only fear is having governments refusing takeover offers out of national security concerns.

Broad energy ETFs (which also include refiners) that encompass this category are XLF, and VDE, but the exporation and producer index (XOP) has been significantly more impacted. XOP has an MER of 0.35%. The Canadian equivalent (and this ETF would provide eligible dividends as it would be from Canadian and not American sources) is XEG.TO and this ETF contains the usual list of Canadian energy producers (Suncor, CNQ, etc.) for an MER of 0.6%.

If you’re brave and have nerves of steel, buy oil. I can’t tell whether right now or the next three months or so will provide the lowest price point, but from a historical perspective, it is closer to the bottom than it was a month ago!