Oil - it's part of our lives

Remember this headline Oil at $147 going to $200.... news from the summer of 2008? This same news article will come out again sometime in the future. Maybe not in 2009 or 2010 but definitely within the next decade.

Read this article on peak oil - http://www.lifeaftertheoilcrash.net/

So how do we protect ourselves from the inevitable? Depending on our lifestyle, upwards of 10-20% of our annual budget is spent on oil - directly in gas for the car, heating bills for the house or indirectly as electricity, food, vacations, clothing, plastics etc.

As a result of our dependency on oil, we need to hedge against a dramatic increase in oil prices.

What's the magic number? It will depend on your personal situation. I am going to focus on large oil companies as small ones are in danger of becoming insolvent in the current credit crunch.

Let's pick Suncor as a proxy (integrated oil, mid-size debt, mid-price) - $20US. Cost to mfg 1 barrel ~ $30, annual output 100M barrels. Other strong large cap companies include Chevron, Exxon Mobil, Canadian oil sands, Royal Dutch or more gas focused - Encana, Chesapeake.

if oil goes to $200, my annual "oil" related costs (direct and indirect) will go from $5K per year to $20K - where am I going to find the other $15K. To cover this cost increase, I need to hedge against this increase - oil futures are risky and time based, so are small companies with short life reserves (some oil/gas trusts), my strategy is to go with a couple of the companies above.

If we just use Suncor as an example, SU has 1B shares outstanding, 100M barrels per year. Oil @$200-$30 = $170 profit per barrel => $17 per share => as a "rough" guide, 1,000 shares of Suncor would be a good size hedge.

Warning: make sure you pick stocks that will survive oil at $30. avoid those with low reserve life, high debt, assets in risky geopolitical areas etc. An example of a recent disaster was Oilexco - from $19 to $0.25.

Investors are starting to add oil back into their portfolio as noted by the recent rise in stock price vs price of oil. This shows that investors are already starting to factor in a recovery in 2009.... check out XOM's (Exxon) chart .... 52 week low in Oct, but then a series of higher lows. Simlar chart as Chevron.

Don't go all in, but everyone needs to have an oil and gas component in their portfolio. Even if you do not believe in peak oil and believe that alternative energy and batteries will reduce our dependency on oil, there is nothing wrong with hedging your lifestyle just in case peak oil is real or if suddenly one day 100million more Chinese and Indian people decide that they wanted to own a car and drive one.