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Oil is the most exciting gamble on today’s stock market

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Oil rig

The oil price is the most critical call on today’s stock market. It’s certainly one of the biggest gambles and short sellers who piled into oil in January will still be licking their multiple wounds. When Brent crude hit $27 mid-month Standard Chartered bank wasn’t the only analyst chancing its reputation by sharing its bearish outlook, but it was the only one I recall claiming the price would fall as low as $10 a barrel. That doesn’t look too clever today, as oil renews its charge towards $50.

Crude guesses

Crude enjoyed another surge on Monday after Goldman Sachs bumped up its WTI forecast from $45 a barrel to $50 in the second half of 2016. It said supply has been disrupted by wildfires in Canada and militant attacks in the Niger Delta, but is hedging its bets every which way. Confusingly, it said: “The physical rebalancing of the oil market has finally started [which] reflects our long-held view that expectation for long-term surpluses can create near-term shortages and leaves us cyclically bullish but long-term bearish.” Clear?

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Personally, I’m cyclically confused by conflicting data but long-term bullish. Oil companies have been in such a hurry to slash costs and production in a bid to survive the current shake-out that this will surely feed through to lower output at some point, and possibly even a nasty supply shock. Demand is widely predicted to revive, unless we have a crash, and renewables can’t yet pick up the slack.

Two-way bet

I also recognise that US shale producers are resilient and investment will flood back once oil tops $50 or $60. Saudi Arabia is rewriting its own rules of engagement after recognising that being a swing producer means losing market share as rivals continue to drill flat-out. The US, Iran and Iraq are all set to add to global supply and if inventories start rising again, the oil price could just as quickly slide.

Only one thing is certain about oil right now: it isn’t boring. Investors in explorers such as Premier Oil and Tullow Oil will testify to that, their share prices are up 142% and 70% respectively over the last three months alone, but down 60% and 42% over 12 months. Given that markets of all descriptions are impossible to forecast correctly on a consistent basis, you have to accept that buying today is a gamble.

Major decision

You can hedge your bet by investing in a vertically-integrated major such as BP and Royal Dutch Shell, which are up 17% and 19%, respectively, over three months (but again, down around 20% on a year ago). Even their dividends are a gamble as they could be slashed if the oil recovery stumbles, but this may be a bet worth placing at today’s respective yields of 7.35% and 7.16%.

The relief rally has wiped out much of your potential gains from smaller oil producers and also leaves new buyers vulnerable to a correction, so you’ve probably missed your moment. However, the price still looks right at dividend-payers BP and Shell, especially for investors who plan to hold for the long-term, to overcome short-term oil price madness.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has recommended BP and Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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