Oil prices staged a remarkable rally in the past year on the back of a weak dollar and a nascent economic recovery.
With stockpiles of oil high and energy demand rebounding, most forecasts are calling for the "black gold" to edge up slowly over the year.
At least, that's what the big firms want you to think.
Goldman Sachs controls over 43,000 miles of pipeline and more than 150 oil storage terminals. Morgan Stanley has the capacity to store and hold 20 million barrels. And these firms have the power to direct billions of dollars of their clients' money into oil.
Which way do you think they will push oil prices?
If you guessed "through the roof" you're right. And, those who invest right along with Wall Street have the opportunity for windfall profits.
Read on to find out how Wall Street can manipulate oil prices…. And how to profit right alongside the "big boys."
How Much Oil Does Wall Street Control?
Right now, "approximately 60 to 70 percent of the oil contracts in the futures markets are now held by speculative entities. Not by companies that need oil, not by the airlines, not by the oil companies. But by investors that are looking to make money from their speculative positions," according to Dan Gilligan, president of the Petroleum Marketers Association.
An estimated 90 million barrels of oil are being hoarded on seaborne tankers by speculators looking to profit from bigger long-term gains.
Many believe that investor demand for commodities, and oil futures in particular, was created by Wall Street hedge funds and the big investment banks like Morgan Stanley, Goldman Sachs, Barclays, and J.P. Morgan. These firms made billions by investing hundreds of billions of their clients' dollars.
"The investment banks facilitated it," said hedge fund manager Michael Masters. "… they found folks to write papers espousing the benefits of investing in commodities. And then they promoted commodities as a, quote-unquote, 'asset class.'"
This is a big reason why oil prices have zoomed up over 116% in the last year, despite ample supply throughout 2009.
This artificially inflated demand will continue to drive oil prices higher in the year ahead… especially as investors flee the falling dollar and seek refuge in hard assets like oil. In fact, many investors are exploring an opportunity discovered by a tiny Texas oil company that discovered oil under the Eiffel Tower in Paris.
Rising Demand for Oil, Just as Production Stagnates
While the dollar is poised to carry on its decline, the global economic recovery is picking up steam.
The Organization for Economic Cooperation and Development (OECD) more than doubled its 2010 forecast for developed nations, saying that strong growth in Asia would help pull the "more feeble" West out of its financial malaise.
And, as the economy rebounds, so, too, will oil demand. The International Energy Agency (IEA) forecasts a sharp pickup in oil demand in 2010, up 1.5 million barrels per day from 2009 levels.
At the same time, the Organization of Petroleum Exporting Countries (OPEC) has issued three production cuts totaling 4.2 million barrels per day, an amount equal to nearly 12% of capacity.
"With global demand growing and OPEC holding production flat, stockpiles are going to come down, and that's bullish for prices," Mike Wittner, head of oil market research at Societe Generale SA, told Bloomberg.
With supply and demand fundamentals driving up oil prices, it's likely that even more investors will pile into oil… driving prices up even further.
In fact, Keith Fitz-Gerald, Money Morning's Chief Investment Strategist, thinks that oil prices could spike as high as $150 per barrel in 2010 – especially if anything happens in the politically unstable Middle East.
Profiting From the Oil Price Spike
Many companies benefit from high oil prices, but one of the best plays this year could be U.S. oil major ExxonMobil Inc. (NYSE: XOM).
A recent cover story in Barron's called Exxon the Goldman Sachs of the energy business, except "Exxon out-Goldmans Goldman."
"Like Goldman, Exxon has a distinctive 'best-and-brightest' corporate culture, and relentlessly focuses on return on investment and efficiencies at the expense of egos," Barron's said.
Indeed, with a world-leading market capitalization of $325 billion, Exxon isn't hiding from anyone. However, the company that set a world record with $45 billion in after-tax profit in 2008 underperformed in 2009.
While oil prices have surged 60% since January 2009, shares of Exxon have dropped more than 14%. Its peer companies have seen their shares advance by more than 33% during that same period.
The company is currently trading at 16 times earnings – a bit below the industry-average Price/Earnings (P/E) ratio of 17.5.
The energy giant had proved nearly 23 billion barrels of oil and natural gas at the end of 2008. Its total energy resources – proven reserves as well as deposits that don't yet qualify as proven – are the equivalent to 72 billion barrels of oil and gas. Exxon has improved its competitive position with its proposed purchase of XTO Energy Inc. (NYSE: XTO), the largest U.S. natural gas producer, in an all-stock deal valued at $31 billion. The buyout is to close in the second quarter of 2010.
The consensus estimate for 2010 is for the company to earn nearly $6 a share. At current valuations, that projects a price of $96. Were the company to deliver on the projected $5.95 a share in 2010 earnings – and to trade at the industry multiple of 17.5 – Exxon shares would trade at more than $100 each. That would represent a 48% return from current levels.
No matter which valuation is used, it's pretty clear that Exxon's shares have some room to run.
Another way to play along with the Wall Street insiders, is to invest directly in one of the small oil companies that they're pouring their clients money into. Goldman Sachs and Barclays are building huge positions in a tiny oil company right now. But they won't disclose the details of their investment to the media – or even their clients. No surprise, they want to keep the gains to themselves.
Their target is a microcap oil company that's discovered 40 billion barrels of oil, worth $2.8 trillion. The company is just days away from bringing this mother lode to market. By investing ahead of the event, these banks could pocket 46 times their money. Find out exactly what they're up to here.
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.