The role of oil as a hedge against Middle East turmoil has evolved over time. While its effectiveness may be limited now, it still offers investors a certain level of protection in the face of broader conflict.
Limited Impact on Oil Prices
The recent invasion of southern Israel by Hamas fighters from the Gaza Strip, resulting in the loss of many lives and hostage situations, did not significantly impact the price of oil. Initially, there was a spike in futures tied to the U.S. price of crude oil, reaching around $86.50 per barrel from $83 per barrel. However, this gain quickly reversed in the following trading days, bringing oil prices back down to $83 per barrel. This lack of a premium in response to such events is not surprising given several key factors.
Changing Dynamics
The United States is now a net exporter of crude oil and possesses a strategic petroleum reserve that helps stabilize global oil supply during disruptions. Although the reserve is currently not at its usual capacity, it still provides a cushion against sudden shocks. Furthermore, the initial attack by Hamas and the subsequent response have had minimal impact on oil supply, which continues to flow seamlessly.
The Value of Oil as a Hedge
Despite these factors, it is worth considering oil as a hedge against geopolitical risks. The conflict between Israel and Hamas is unfortunately expected to result in significant casualties. This, in turn, may compel other regional powers such as Iran and Lebanon’s Hezbollah to respond. In an extreme escalation, even the United States might become involved. While long-term dynamics need to be considered separately, the immediate market response to any negative news from the Middle East will likely drive oil prices higher.
Christyan Malek, J.P. Morgan’s global head of energy strategy, expresses this sentiment by stating, “We believe this is an example of an emerging risk premium related to diminishing spare oil production capacity, and we expect short term spikes to continue over the medium term while becoming more sustained.”
In conclusion, although oil may not provide the same level of hedge against Middle East turmoil as it has in the past, it still retains a certain value for investors seeking extra protection in times of conflict.
Investing in Oil: Navigating Near-Term Odds
Investing in oil can be a lucrative opportunity for investors looking to capitalize on the current market dynamics. While there are both upside potential and downside risks, understanding the key factors at play can help inform investment decisions.
Assessing Near-Term Dynamics
The current supply and demand dynamics indicate that the price of oil is unlikely to fall below $75 per barrel in the near term. This level of support has been consistent throughout 2023, providing investors with confidence in the stability of the market. However, it’s important to note that an escalation in fighting could lead to a spike in oil prices, potentially reaching $100 per barrel. This represents a potential upside of around 20% from the current price of $83 per barrel, while the downside risk remains below 10%.
Exploring Investment Options
For investors interested in betting on a higher oil price, there are several exchange-traded funds (ETFs) that provide easy access to the market. The U.S. Oil Fund (ticker: USO) tracks West Texas Intermediate crude oil prices, offering exposure to the U.S. market. On the other hand, the United States Brent Oil Fund (BNO) tracks the international benchmark oil price.
For those with a higher risk tolerance and seeking greater potential returns, the ProShares Ultra Bloomberg Crude Oil (UCO) ETF presents an option. This ETF aims to double the daily performance of the WTI oil price, allowing investors to profit from both upward and downward movements. It’s important to note that leveraged ETFs like UCO should be treated as short-term trading vehicles rather than long-term investments due to daily rebalancing, which can result in losses over time.
Alternatively, investors can consider going long on shares of oil producers. These companies directly benefit from higher commodity prices, and their bottom lines are likely to improve accordingly. The iShares U.S. Oil & Gas Exploration & Production ETF (IEO) is a good option for exposure to North America-focused oil companies such as ConocoPhillips (COP), EOG Resources (EOG), and Marathon Petroleum (MPC). Since the recent attack on Israel by Hamas, this ETF has already seen a growth of over 4%.
Conclusion
Investing in oil can offer significant opportunities for investors who carefully analyze the market dynamics. By considering the available investment options, such as ETFs and oil producers’ shares, investors can make informed decisions to maximize their potential returns.