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Global Financial Crisis Makes Oil a Great Hedge

by: Jason Schwarz October 08, 2008 | about stocks: DBO / OIL / USL / USO    

Jason Schwarz

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The global slowdown is here to stay and the best way to play it is with oil (USO) puts.  One could argue that even without a global slowdown oil puts would be a great investment (as in here); with the global slowdown, this one’s a no brainer.  Crude oil prices reached a bubble high of $147 in July after a seven year climb.  With current prices hovering between $90-$100 a barrel, this commodity has a long ways to fall.  There are various ways to play the global slowdown (for other ideas check out our investment newsletter at www.lonepeakportfolios.com) but this one trumps them all.

Earlier this week the Chinese government said they have more than enough gasoline stockpiles because of the dramatic slowdown in their economy.  As a result, they won’t be importing any refined gasoline for the second month in a row.  This announcement comes on the heels of consistent United States demand destruction throughout the summer months.  Bad news for oil bulls.  It all comes at a time when oil exploration rigs are booked out for years to come and alternative energy sources like natural gas, nuclear power, wind, coal, etc... are about to be implemented in a major way by the next US President.

Investors have been searching for the perfect portfolio hedge but many have come up empty because of the already low valuations in the weak sectors of the market.  Housing seems like a great hedge against equity long positions but the sector has plateaued at the bottom for months.  Financials offer a similar story.  Everyone would love to own financial puts as downside protection but the sector is up over the last three months. 

Oil is your new hedge.  Its multi-year climb is over and investors can now count on this play to protect their portfolios over the next year.  When you gain conviction that the time has come to put cash back into the market, make sure you protect yourself with some oil puts.  Even when the market rallies, oil’s rise will be subdued and short lived because the global slowdown isn’t going away.

Disclosure: Author owns USO put options.

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This article has 15 comments:

  •  
    Oct 08 08:03 AM
    Maybe. But this is a short-term trading strategy. Just do a google search on "Cantarell" or "Burgan", and you will find stories about the declining production rates of 2 of the world's biggest oil fields, in Mexico and Kuwait, respectively. The steep falloff in Cantarell production will have a major impact on the Mexican economy.
    Reply
  •  
    Oct 08 08:16 AM
    Jason....I wonder if your last sentence will still apply when the "heating season" starts?
    Reply
  •  
    Oct 08 11:00 AM
    Interesting article and comments.
    Reply
  •  
    Oct 08 11:23 AM
    I disagree. Peak oil is real, and so long as usage outstrips supply (or is close to it) oil will remain high.

    We have entered a pretty bad economic step, yet oil is still trading above 80. There is a reason for the high price. Previous down turns would have brought crude to the 20s. The fact that oil is remaining high, in a real global crisis, is no accident.

    I would be very careful shorting oil here (and i had no problem shorting oil in the high 130s/140s due to anticipation of the current hick up we are now in).

    Peak oil is real, and the only thing that will merit lower usage of oil is when alternatives are truly being used. Right now they are not. (wind, solar, nuclear... all for electric generation. crude is not used for electric generation, and the battery powered car will not make a dent in the use of oil for at least 5-10yrs.)

    I would be cautious shorting crude here.
    Reply
  •  
    Oct 08 12:59 PM
    It's impossible for demand to outstrip supply as econ101 clearly states that price fluctuates to equilibrate D and S. Stop just repeating what Pickens is saying on CNBC, there can't be 87mbd demand with only 85mbd of production or we would be eating through all the oil inventories at rapid pace...clearly this isn't the case.
    Reply
  •  
    Oct 08 02:03 PM
    Oil reached a bubble high after a seven year climb. Hmm. Most of oil's climb took place over about two years---maybe less. The big question of course is the global slowdown, because when that ends, the financial market mess is cleaned up and the recovery begins to pick up steam, then the oil price will start up again. I'm not sure that Pickens is correct here, but the CEO of TOTAL was probably correct when he said that global oil production will never exceed 100 mb/y.
    Reply
  •  
    Oct 08 05:28 PM
    Russian Oil output has fallen for ninth straight months and its the largest exporter after Saudi. Total exports fell 10 percent year-on-year to 5.14 million barrels a day. That matches the decline in demand in the US and with Mexico and North Sea in decline we increasingly rely on OPEC. A lot Canadian oil sands are not profitable below $80, they are already talking about reducing the investment. Some OPEC members want to cut production, Saudi already has. Shorting oil could more risky than you think if OPEC decides to defend $90 to £100. Yes it could touch $70 for but then reverse rapidly. Your relying on demand destruction which has its limits in the short term, your still got drive to work and heat your home.

    Longer term there is the problem that most production comes from old oil fields and going into decline and the credit crunch is already affecting investment in new Oil fields and where are these people going to get the credit to build the nuclear, most of the cost of them is the finance, same with Wind.
    Reply
  •  
    Oct 09 12:42 AM
    I've got to agree with those who point out heating season hasn't started (although the Midwest is experiencing subnormal temps, currently), and OPEC HAS been pretty quiet, lately. I can't help but wonder how long that will last, given that Iran and Venez. (among other exporters) need high oil prices to keep their economies propped up.

    Despite being bullish on oil, I thought at $145/$150, it was over-bought (thinking a floor of $100/$95), but also think that < $90, its oversold.
    Reply
  •  
    Oct 09 08:30 AM
    Keep shorting this stuff! I've been shorting through all the ETF's since July and making a killing. I don't see any sign of bottom yet. Inventories are still high, demand is still dropping, people are still trying to conserve, there are desparate searches for alternatives, world economy is still slowing..... Why go long on a product that everybody, everywhere is trying to conserve on?? In addition, it now costs alot less to fill my tank, giving me more money to short with....
    Reply
  •  
    Oct 09 12:00 PM
    Schwarz is just another short term thinker. Peak oil is real and the demand will return just as soon as the economy rebounds. China's 1.2 billion and India's 1 billion people want to live just like we do in the US. No way oil will stay below 100 a barrel.
    Reply
  •  
    Oct 09 12:22 PM
    J.D. Power just said that the auto market will COLLAPSE in 2009.. Oil is headed back to where it was or BELOW that price before the big speculative upward scam it made from last year. What was its price in 2007 PEOPLE, remember..??? Why has the world changed from 2007, it hasn't, its gotten worse for oil, SOOOOOOOO..!!!! Oil prices are headed to $65 or lower, either by year end or early next year.. If the economy tanks further we might see $45.. Peak oil or not, you WON'T see $145 for a long time to come.. OPEC can't control input, only output, and REMEMBER, OPEC members always cheat on their production goals, ALWAYS..LOL..!!!!

    If the economy doesn't rebound for another 10 years, what then..??? Iceland is almost declaring backruptcy today, whats next..?? He's right about China, they are NOT importing ANY gasoline anymore, doesn't that make any of you dummies think a little..LOL!!! Oils toast for the forseeable future, maybe in 3-4 years..
    Reply
  •  
    Oct 09 01:32 PM
    It seems like there's always something missing in these analyses: there is a price point at which the producers will simply stop producing.

    Why on earth would I produce oil if I'm losing money on each barrel? I'm going to shut in my wells and tell everyone to go home.

    Oil is NOT getting cheaper to produce. It is getting more and more expensive to produce. The world is still dependent on it for virtually all of its transportation needs. Go short if you must, but only on a short term basis, please.
    Reply
  •  
    Oct 09 01:45 PM
    Scammy: I agree with you. Oil is down for the forseeable future. But like you said, maybe in 3-4 years. To me, that's short term. I plan to watch oil carefully over the next 5 years. At some point, I'll buy in. In twenty years, I expect to at 5x my money. Not a get rich quick scheme but good a return anyway.
    Reply
  •  
    Oct 10 09:17 AM
    I live in the northeast and know several people who have switched to coal, wood pellets & natural gas. Demand for home heating oil will be down, permanently.
    Reply
  •  
    Oct 11 07:07 PM
    Even though petroleum products are following the recession like everything else it will return to its peak. I spent over 40 years in the petroleum business and it will never, ever go down for very long. There are too many players that need oil and natural gas. It is used not only for fuel but in plasics, tires, road building, computer cases, packaging, etc. the list goes on and on. Nothing is as important as petroleum. Our economy depends on it and now the world depends on it. It is a diminishing resource and for a long time to come there is nothing to replace it.
    Reply
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