Crash into Cash -- How to Profit from the Oil Plunge
These days you can't drive past a gas station without smiling.
Unless you're personally invested in the oil sector. In that case, we extend our sympathies.
U.S. crude oil prices are coming off a week from hell, complete with one of the largest one-day drops since 2010. U.S. and Brent crude barrel prices have been hovering in the mid 40s.
Yet surely things have bottomed out, right?
Not so fast. That's what "experts" said when oil dropped to $75. And $65. And $55.
You get the picture.
Bank of America just revised its crude oil price forecast. They're predicting Brent crude could drop to $31 by the end of this quarter. Even that dismal estimation might prove optimistic.
So what's the problem? Why can't the slide be arrested?
It's basic supply and demand. The global oil market is flooded with product. Fracking and other new technologies have significantly increased supply. OPEC has declined to reduce output.
Meanwhile, the world's formerly insatiable desire for black gold has abated. Europe is mired in an economic malaise. Even China -- an energy hog nonpareil -- is dealing with slowing manufacturing and construction demand.
At least a resurgent U.S. economy bodes well for the oil sector, right?
If only it were that easy. State unemployment benefit claims just shot up to a four-month high. The Philadelphia Fed also dropped bad news about regional factory activity.
Are these dire developments? Not exactly. Yet they could be read as evidence the U.S. economy isn't as strong as we think.
Wall Street certainly read it that way. The S&P 500 dropped for almost a week straight.
Short term, oil is still in big trouble. We may still be quite a distance from the bottom.
Which raises an important question: What does this mean for the long-term wealth builder?
How can you profit from the plunge?
Let's find out.
Turning a crash into cash
Perspective is a wonderful thing. It allows us to place events in a broader context. We can see and benefit from the big picture.
Market analysts are hypersensitive to even the smallest development. Yet long-term wealth builders must take a more expansive view.
Could oil keep dropping? Sure. Is $100 per barrel oil a thing of the past? For awhile, perhaps.
Here's the more relevant question: Is oil going to remain cheap over a long time horizon? That's highly doubtful. Even if China slows its development, India, Brazil and dozens of other countries need oil to fuel growth.
Much like land, we only have a finite supply of the stuff.
Humans have a long history with oil. Nearly 2,000 years ago, Chinese laborers used drill bits attached to bamboo poles to create oil wells hundreds of feet deep.
Back then, they used oil to produce salt. These days, it's integrated into almost every facet of our economies and lives.
It's precious. It's finite. And it's eventually going back up in price. You want to be onboard when that happens.
Benefiting sooner rather than later
What if you're looking for returns on a shorter timeline? Good news -- there are plenty of smart plays to be made.
With oil prices at rock bottom, fuel is cheaper than it has been in ages. Airlines -- not always the safest investment -- stand to profit enormously. Fuel is typically the largest expense for airlines.
Airlines that don't hedge fuel costs -- or hedge a low percentage -- are of particular interest.
Other companies in the transportation space should thrive. Low fuel prices are a major tailwind for trucking firms.
What about oil? Here's where it gets tricky. The oil collapse has created many great bargains. It's also created many portfolio-busting hand grenades.
It's also important to differentiate between the two most important types of oil companies.
Those that can still make money when prices are low -- and those that can't.
An extended oil slump is going to put some of the latter companies out of business -- or make them acquisition targets.
Companies like Exxon and Chevron have an integrated business model. They use refineries to create gasoline and jet fuel.
This means low oil prices can actually help their bottom line -- at least for awhile. Cheaper oil makes the refining process less expensive.
Other oil companies, like Marathon and ConocoPhillips, decided to spin off their refinery business. That's a decision they are likely ruing today.
Large, cash rich companies with integrated models and access to cheap oil are well-positioned to ride out the crisis. If you're bullish on oil long-term and want to go the easiest route, an oil ETF is always an option.
By investing now, you can peg your own financial fortunes to the oil recovery, to a certain degree.
That's not a prescription for everyone. Oil is volatile.
Yet it also represents a fantastic opportunity to build wealth.