Short supply will start to push the oil price up

AFTER the furore following the BP oil well disaster, it now seems like crude oil is the only commodity that people aren’t talking about. Surges in the price of cotton, wheat and even orange juice mean soft commodities are hitting the headlines on a daily basis. In contrast, movements in the oil price have been rather predictable in comparison, with crude fluctuating between $70 and $82 a barrel – a range it has held since the start of May. Spot Brent crude oil was yesterday trading at nearly $79 a barrel while the West Texas Intermediate futures contract was at $75.

While no immediate break out of this range is expected, most analysts hold at least a moderately bullish view on the oil price in the long-term thanks to emerging markets’ thirst for energy. If you have a long-term view, then this should ensure plenty of upside for the price of oil.

And although oil is some $5 a barrel more expensive than it was at the end of August, now appears as good a time as any to go buy oil through longer-term investment vehicles such as exchange-traded funds (ETFs) and covered warrants.

“Better demand conditions should lead to a fall in commercial inventories, supporting a higher oil price at the end of 2010. Our short-term price forecast are for only a modest rise in the oil price to $78 a barrel by the end of 2010 and $81 a barrel by the end of 2011,” says Carl Paraskevas at Lloyds TSB Corporate Markets.

And it is not just demand that is supporting the oil price. In fact Killik & Co believe that it is the supply side of the equation that is particularly positive for the oil price: “In the short term, supply is being constrained following the slowdown in capital expenditure during the recession. Further out, the International Energy Agency believes the rate of production decline from existing fields will rise from 6.7 per cent per annum to 8.6 per cent per annum in 2030 – and possibly higher if infrastructure investment falls short,” they write in a research note on the oil sector.

Although there has been plenty of volatility in the oil price over the past couple of years, $70 a barrel is seen as a strong fundamental support level. On the upside, a real oil price above $120 a barrel remains a key fundamental resistance level, as a sustained period of prices above this level risks further substitution of oil for other fuels by OECD economies, warns Lloyds TSB’s Paraskevas.

For those using ETFs, you can get exposure to crude oil through providers such as db x-trackers, ETF Securities and Source. And both RBS and Societe Generale offer covered warrants on Brent crude oil futures. For example, Societe Generale has call warrants with strike prices ranging from $75 to $150. These will be in-the money if the oil price exceeds the strike price on or before a pre-determined date.

While it might be worth waiting for some short-term dips to buy in to the market at a cheaper level, those with a long-term view should be looking to take a bullish position on oil before the price rises further.