How to Invest in Rising Oil Prices

The U.S. Energy Department says the price of oil will average about $93 a barrel in 2011.

By SHARE

You've probably noticed at the pump: The price of oil is rising again. Experts have ratcheted up their growth projections for the new year, which typically means they expect the price of gas to move higher as well.

"We're expecting strong economic growth, and that's always the No. 1 driver for crude oil," says Brian Hicks, co-manager of U.S. Global Investors Global Resources Fund (PSPFX).

There are a number of factors contributing to Hicks's expectation of higher gas prices. "Despite record levels of investment into crude oil production, we haven't seen a significant increase of non-OPEC crude oil production, so that gives OPEC stronger market share and stronger control of the market, and it implies prices will be going up," Hicks says. On top of that, he says new oil supplies are coming from higher-cost areas like deepwater drilling, which will also push prices higher.

[See 5 Investment Themes for 2011.]

Plus, demand for oil is only going up. This month, the U.S. Department of Energy raised its outlook for global oil consumption to a record-high 88 million barrels a day in 2011. Most of that growing demand is expected to come from the emerging markets countries like China and India. The price of oil will average about $93 a barrel this year, up from December's forecast of $86, according to the Department of Energy. Craig Hodges, co-manager of the Hodges Funds, says oil will fluctuate between $90 and $100 this year. But he believes the real spike will come in 2012. "It becomes a math equation at some point," he says. "The world can only produce so much oil a day." In 2012, prices are estimated to average about $97, about $2 short of the record high in 2008.

When it comes to investing in oil, investors have a few options, including investing directly in the spot price of oil through exchange-traded funds or in the stocks of oil-related service and drilling companies.

Hicks says he's invested in Texas names like drilling company Pioneer Natural Resources, and also globally in producers like Apache, which has operations in North America as well as Egypt and Australia. He also likes big oil equipment and services names like Halliburton. For investors who don't mind taking on a little extra risk, Hicks favors investments in oil companies in Colombia like small-cap name Gran Tierra Energy.

[See How to Navigate the Bond Market in 2011.]

Hodges says investors should look to areas that are out of favor, such as deepwater drilling companies in the wake of the BP oil spill in the Gulf of Mexico. "The surest money will be made in the deepwater drillers," he says. "It's a very under-owned area because of what happened." He likes Transocean, even though it was involved in the spill, along with Atwood Oceanics, a small-cap driller with global operations.

Besides individual stocks, there are a number of oil-related ETFs for investors. ETFs have revolutionized the way investors can gain exposure to commodities in their portfolios. But of all commodities, oil is still one of the most difficult to invest in directly. Precious metal exchange-traded funds like SPDR Gold Shares (symbol GLD) and iShares Silver Trust (SLV) have garnered a lot of attention recently because the underlying metals have performed so well. These ETFs allow investors the ability to invest in a fund that owns physical bars of gold or silver. If you want to invest directly in oil, you must invest in an ETF that tracks a basket of futures contracts.

[See The Case for Investing in Commodities.]

Tom Lydon, editor of ETFTrends.com, recommends United States Oil ETF (USO) and PowerShares DB Oil (DBO). Both track a basket of futures contracts that follow the price of oil. Investors can use these funds to hedge against the prospect of oil prices rising, or if they simply believe oil is heading higher. It's important to note that these funds won't move dollar-for-dollar with the price of oil because investors have to pay a premium to invest in futures contracts. In a recent report, Morningstar analyst Abraham Bailin wrote: "Predicting oil prices is an extremely difficult task that should be approached with caution or, some may argue, avoided altogether."