Invest in the Oil Bottom

Back in January, my colleague Briton Ryle wrote the following in an excellent column for Wealth Daily: “Bottoms are V-shaped; tops are a process.”

This short, simple phrase offers a storyline for the last few months for the oil market.

As you can see in the chart above, we saw a clear V-shape in March, and there has been a fairly strong rebound since.

Of course, as Brit says, tops are a process, and the last couple of weeks have been emblematic of that for oil prices. One day we’re up 2% to 3%, and the next we’re back down…

The chart shows this, too.

But since tops are a process and we have a clear bottom, it’s only a matter of time before oil prices turn recent volatility into a gradual upward momentum.

It’s all part of the process.

This volatile process of oil prices picking up steam is when investors worth their salt will make money over the next six months and for several years to come.

Let’s be honest, too: It should’ve been no surprise that oil prices fell last year when the U.S., Russia, Canada, and Saudi Arabia were pumping astronomical amounts of crude. The pace of the drop — exacerbated by OPEC — was the surprising part.

So commodities investors shouldn’t be shocked when prices trade between $75 and $85 per barrel by the end of the year.

Instead, they’ll be thrilled when they look at the capital gains on investments made during the bear market.

Supply Squeeze in Middle East?

As we so often do when talking about oil, we have to discuss the Middle East. This past year has been another chaotic one for the region.

Last June, ISIS invaded Mosul and, in a massive putsch, conquered a huge piece of territory ranging from Syria into the northwestern regions of Iraq.

The terrorist group builds its revenue and funds its operations by seizing oil wells throughout the two war-torn countries.

Libya in Northern Africa has seen its share of violence, too. Things looked hopeful when warring factions agreed to split up oil sales last year, but that agreement has since fractured, and fighting has forced producers to evacuate workers form certain areas and export less oil.

Then in another coup earlier this year, Yemen saw a band of Iran-funded Houthi rebels oust President Abd Rabbuh Mansur Hadi, who had been installed by Saudi Arabia just a few years ago.

For nearly three months, the Saudis have air bombed rebel strongholds, but little damage has been done except to civilians and critical infrastructure — all in order to protect the Bab el-Mandeb strait, where oil flow is critical for the Saudis.

And in the first half of 2015, it seems Iran is the victor in its unending proxy war with the Saudi Kingdom, as the United States, Russia, and other world powers are close to signing a nuclear deal that will lift sanctions in Iran.

This is what’s worrying oil investors these days…

As you can see, after Iran was hit with strict energy sanctions back in 2012, the country’s production and exports dropped off dramatically.

Now with a deal in the cards, it seems Iran will add even more oil to an already oversupplied market.

Officials there say the goal is to boost production by about 1 million barrels per day in the first six months or so without sanctions. From there, Iran expects oil production to grow to 5 million barrels by 2020, which would add more crude to an already saturated market.

If it happens the way the bears believe, oil prices will crash once again, perhaps even lower than they did at the beginning of this year.

But it’s important to remember that the nuclear deal is anything but complete, and it’s impossible to know if Iran can make its bold claims happen.

Plus, take a look at this…

Iran consumes a great deal of its oil for power production, and once sanctions are lifted, the country will see a fast-paced boost in economic activity.

As we know, jumps in economic activity and GDP require vast amounts of power production. So despite calls for a renewed glut, the Iranians will consume much of the oil they produce during the first few years of sanctions relief.

Again, this is only if a deal happens, but plenty of hardliners in the United States and Iran seem bent on thwarting any agreement.

So for investors, now is the time to rebuild positions in oil companies.

West Texas or Bust

Even though I’m bullish on oil since it’s so cheap right now, I still always urge caution.

The goal is to make money, not gamble it all away.

Although many investment analysts, including my co-workers at Energy and Capital, love North Dakota and the Bakken, I think there are better plays in Texas…

Namely the Permian Basin, which benefits from a wealth of oil and natural gas reserves, better access to pipeline infrastructure, and close proximity to Mexico, where oil swaps will gain steam over the next few years.

When oil goes up, it’ll be the shrewd players during the bear market that rise first on the market.

Good Investing, 

Alex Martinelli

With an eye squarely focused on the long-term, Alex Martinelli takes the art of income investing to a higher level within the energy sector. His research has helped hundreds of thousands of individual investors identify well established companies that have a long history of paying out dividends to their shareholders. For more info on Alex, check out his editor’s page.