The easy trade these days appears to be in crude oil, and to a lesser degree, commodities.

My trading gut instinct says that the crude market may be a tad overextended at the moment, presumably due to geopolitical instability.

Modern historians should note that Iran and Iraq went through a decade-long war, yet the Persian Gulf still managed to export billions of dollars of crude.

The big shoe to drop is the answer to the question of “What happens in Saudi Arabia?” since they control a significant source of supply globally. That said, it is highly likely that the oil will still flow since whoever is left to control government will still want the cash cow – what will be significantly more disruptive is that the incumbent administration knows it will be kicked out, but has plenty of notice of its pending demise. In this scenario, they will likely use the “scorched earth” option, similar to what Saddam Hussein did in Kuwait prior to the first Iraq invasion.

Readers will likely note that their holdings in Canadian oil sands related companies have received a significant amount of appreciation over the past 6 months – partly related due to the market conditions and improving economy. Here is a chart of Cenovus (TSX: CVE), but you can pretty much fill this in with the usual suspects (Suncor, Canadian Natural, etc.):

The last spike up over the past month is a function of higher crude prices and geopolitical instability – I’d estimate of the $6 that it has gone up from $32 to $38, half of that is due to crude, and half of it is implied instability.

That said, it seems like an easy trade to pile in at the moment, so be very cautious – when others think alike, your risk/reward ratio becomes more adverse.

Anybody investing in oil should know the fundamentals of how the oil is extract out of the ground. The traditional (called conventional) method is used in places like Saudi Arabia – sticking a tube in a strategically-located position in the ground and sucking up the contents.

Steam-Assisted Gravity Drainage was an invention that has lead to the opening up of oil reserves that otherwise would have been inaccessible. There are quite a few companies in the Alberta area that use this to mine oil. A very basic example of how this works is on Cenovus’ website, which is semi-education and semi-corporate propoganda.

Cenovus used to be part of Encana, Canada’s largest natural gas producing company. They split off last year.

The other form of mining, taking tar sands (bitumen) from the surface and processing the material, is done by companies such as Suncor, and generally give the industry a perception of being environmentally damaging.

As the price of oil continues to increase, alternative methods become increasingly economical and it is well worth it for an investor to educate themselves on the processes used to extract energy from the earth.