(By Martin Hutchinson) Crude oil is knocking on the door of $80 a barrel. That's not what experts have been expecting. At the start of the year, when oil prices were below $40, these experts predicted prices would stay there, or even decline a bit.
But the truth is, an explosion in the world money supply, particularly in China, has fueled oil-intensive growth and caused crude prices to reverse their decline of late 2008. This trend is likely to last for at least the next several months. So how should investors play it?
The underlying cause of the continuing explosion in oil prices is the loose U.S. monetary policy that central banks around the world put in to counter the banking crisis and have kept there. In the United States, interest rates remain at zero – even though inflation is already creeping up towards 3%.
In Britain and Japan, interest rates are also close to zero. In the European Union, the "official" short-term rate is 1%. Chinese interest rates are higher, but China's total money supply (M2) rose 27.9% in the 12 months through September. So there's a lot of money sloshing around, and this time it's not going into stocks or housing, but into commodities and energy.
Don't forget the expansion in China and India's automobile markets, either. China's motor vehicle sales are expected to surpass U.S. sales this year, rising around 35% to 11 million vehicles, while India's have also been rising rapidly, and this year are forecast to be up 25% to 2.5 million. All those new cars need fuel, and that's why demand for oil hasn't weakened as people expected, but has continued to advance.
Monetary policy in the United States won't change for some time – the U.S. Federal Reserve recently said so. That's also likely to be true around the globe, maybe with the exception of an occasional quarter-point increase like we saw in Australia, recently. So oil prices are likely to continue rising for months to come.
The New Rules for Oil Investors
Traditionally, we play increases in oil prices by buying stock in the major oil companies. That's not the way to go today. The problem is that the majors don't actually have all that much oil.
Furthermore, much of the oil they produce is in difficult countries, and when prices go up, those countries tear up contracts to make sure they get all but a thin sliver of the profits.
