Black gold: As oil price dips, what investors should consider

By Dian Vujovich
Special to the Daily News

Oil. It's one of Mother Nature's treasures that has made fortunes for many, while decimating the wealth of others.

Today, with prices averaging $2.13 per gallon nationwide for regular gasoline, and oil trading at under $50 a barrel, levels not seen for years, it's an undeniably hot subject. But as the media gushes about how the price of crude translates to cheaper fuel at the pump, there's more to the story than pricing. Here are four topics investors should consider:

1. Not all oil is identical.

"Oil comes in a variety of standards because it is composed of varying compounds that depend on its local geology, among other things," says Jeff Tjornehoj, head of Lipper Americas Research at Thomson Reuters. "West Texas Intermediate and Brent are but two of many different standards of crude oil. Crude only means unrefined."

The most quoted benchmark for oil is Western Texas Intermediate, or WTI. "There are technical differences between the two terms like 'heavy' or 'light,' and different sulfur content," said Derek Hong, senior investment adviser at PNC Bank's Palm Beach office. "It is easier for refiners to produce gasoline out of the low sulfur or sweet crude, like WTI ... which is the main benchmark used for pricing oil that is consumed in our country."

Hong added that Brent is a more popular indicator of global oil prices because it is the index representing oil fields in the North Sea.

2. Lower oil prices carry pluses and minuses.

An obvious plus of lower oil prices is cheaper gas at the pump. This has translated into people having more money to spend and invest and can boost the economy.

"At the national level, each one-cent-per-gallon reduction in the national average price of gasoline, if maintained for one year, puts an extra $1.1 billion into consumers' pockets," Mekael Teshome, PNC Bank's Florida economist, said in an email.

Teshome added that lower energy prices can slow inflation, reduce manufacturing costs in energy-intensive industries and as a result "strengthen American manufacturing's competitiveness."

They also keep yields on fixed-income securities low and have reduced the U.S. trade deficit. Data from the U.S. Census Bureau and the U.S. Bureau of Economic Analysis show that the U.S. trade deficit was down 7.7 percent, from $42.2 billion in October to $39 billion in November.

On the downside, falling oil prices have already resulted in a loss of per-share value for many investors, The combined loss in value of global oil and gas stocks has been estimated at $3 trillion. Industry-related jobs also have been lost.

Lower oil prices mean tax revenues will decline in states that rely on income from energy production and at the same time it's opened the door for talk about increasing the current gas tax.

3. When is a good time to invest in oil and gas companies?

The answer most pros give: "It depends."

It can depend on the risk investors are willing to take, on their time horizons and on their selections.

For the extreme risk taker, falling oil prices have devastated economies in countries such as Russia and Venezuela. For investors with guts and time, investing in countries like these could hold some appeal.

There also are a variety of hedge fund strategies to select from. Regarding hedging investment strategies, money can be made no matter what direction oil prices are headed. For the more conservative investor, PNC's Hong said those with three- to five-year time horizons might consider investing in large, integrated oil companies with attractive dividend yields and strong balance sheets such as Exxon Mobil, Chevron or ConocoPhillips.

Tjornehoj said the Energy Select SPDR (XLE), an ETF, is down 23 percent over the past year. "That looks like a good discount on some very large oil companies, none of whom will go out of business anytime soon," he said.

For those who predict oil prices will continue to drop, he suggests to wait before investing, use dollar-cost-averaging and buy over time or consider ETFs.

4. Things to consider before putting money into this sector.

First, cheap oil prices are likely to be around for a while.

In a Jan. 12 Bloomberg.com story by Dan Murtaugh, "Oil Producers Betting On Price Drop With OPEC not Curbing Outpur," comes this: "The Organization of Petroleum Exporting Countries, which pumps about 40 percent of the world's oil, has stressed a dozen times in the past six weeks that it won't curb output to halt the rout. The U.A.E. won't cut production no matter how low prices fall, Yousef Al Ataiba, its ambassador to the U.S., said."

Second, don't panic. This isn't the first time oil prices have collapsed in an effort to control that market.

According to a piece by Gary Alexander in the January Louis Navellier Marketmail email, there have been times that oil prices has fallen 50 percent or more and recovered in months rather than years.

Examples from that piece include Saudi Arabia flooding the world with oil to gain market share in 1985; Saddam Hussein pushing oil prices up in 1990 by invading Kuwait; and the steepest cut, in 2008, during the financial crisis when the prices on commodities that had soared were halved.

Because the price of oil has dropped almost 50 percent and there continues to be a glut of it in the marketplace, how low prices will go remains unknown.

Goldman Sachs Group Inc. recently said crude oil needed to drop to $40 a barrel to "re-balance" the market. If that's correct, how long crude will stay at that level, or increase in price, is the billion-dollar question.

But given that the price drop is costing all 12 OPEC members billions of dollars in lost revenues, and the group reportedly has no plans to meet again until June, enjoy the cheap gas. It won't last forever.