A case for investing in oil — and natural gas

While last week’s rumors of an OPEC production hike trimmed crude oil by a few dollars, energy prices are likely to keep climbing for quite a while.

And if history is any guide, oil — which is trading at just under $90 a barrel, up from the $34 trough reached in February 2009 — could be heading higher very soon.

According to the Stock Traders Almanac, oil prices have rallied from mid-February through mid-May in 23 of the past 27 years.

According to Jeffrey Hirsch, the almanac’s editor-in-chief, the seasonal upsurge is due to continuing demand for heating oil and diesel fuel in Northern states and to the annual shutdown of refineries as they switch from heating oil to gasoline production in anticipation of the summer driving season.

“[The shutdown] has refiners buying crude in order to ramp up production for gasoline,” he said. “It is that early February break that can give traders an edge by buying low in a seasonally strong period.”

For tea leaf readers, the long-term relationship between oil and natural gas prices may be indicating that higher prices are in store for natural gas, too.

Historically, a barrel of oil has traded at about 10 times the price of a British thermal unit of natural gas. This ratio held true even through the extreme price run-up to July 2008, when oil reached $147 and natural gas hit $15.

At the moment, oil is trading at nearly 20 times the price of natural gas, which is holding close to $4.50 per BTU because of excess supply and transport limitations. Market watchers are not sure what to make of the unusual divergence from historical norms. Logic would suggest that convergence can return only as a result of lower oil prices, higher natural gas prices or a bit of both.

With oil prices looking determined to climb, some investors are betting that the convergence will result from a strong price rally in natural gas. Last year’s 12.2% gain in the First Trust ISE-Revere Natural Gas Index Ticker:(FCG), which tracks production companies, suggests that the market believes natural gas will go higher. At the same time, the 40% drop in the commodity-tracking United States Natural Gas ETF Ticker:(UNG) suggests not everyone agrees.

A look at the futures contracts for both oil and natural gas through February 2014 shows evidence of some convergence, but nothing to suggest that oil will be trading at less than 16 times the price of natural gas. That ratio translates to a longer-term price divergence of 60% outside the historical average, and that means higher prices for both oil and natural gas.

One-way investors can track the price of oil is through United States Oil Ticker:(USO), an exchange-traded fund that invests in futures contracts for West Texas Intermediate light, sweet crude oil. (For insights into the tax treatment of energy-related ETFs, see Tax-Conscious Adviser on Page 22.)

Several ETFs also provide exposure to diversified baskets of integrated oil and gas companies, the largest of which is the $8.6 billion Energy Select Sector SPDR (XLE). Others include the iShares Dow Jones U.S. Oil & Gas Exploration & Production Index (IEO), the iShares S&P Global Energy (IXC) and the Vanguard Energy ETF (VDE).

And if all the technical and historic rationales for higher energy prices aren’t convincing, there are always the fundamentals.

“We think the trend will be higher oil prices because the expectations for real [gross domestic product growth] are becoming rosier, and that’s a big factor for oil prices,” said Stewart Glickman, an equity analyst at Standard & Poor’s.

“When GDP is up, companies spend more and consumers spend more,” he added. “In a lot of ways, oil is like the lifeblood of the economy.”

Questions, observations, stock tips? E-mail Jeff Benjamin at [email protected].