Crude Oil On Fire: Examining The Commodity’s Rise

Arguably the world’s most popular commodity investment, crude oil, has been subjected to a wild 2011. Recently, the fossil fuel has been making headlines for its significant gains, though just a few months ago the opposite was true. Now that crude recently broke through the triple digit mark (at least temporarily), investors are trying to figure out why the commodity has surged in recent weeks. Given all of the economic turmoil around the world and the volatility in equities, it may seem surprising to see crude appreciate so rapidly, but a quick overview of the year sheds light on its recent tear [see also Crude Oil Guide: Brent Vs. WTI, What’s The Difference?].

Starting in late 2010 and persisting through 2011, there were a number of uprisings in Egypt, Tunisia, and Libya. During that period of time, crude oil prices began to spike as supplies hit a bottleneck and many investors realized that some of the most powerful oil suppliers would see output dip. But after a while, crude prices took a hit, as the realization dawned that these uprisings overthrew a number of government structures, meaning that an organized effort to get crude production back up and running would be a ways off [see also Major Countries Burn Up Crude Reserves: Big Oil In Trouble?].

Now, another uprising in Iran and Syria have investors worried again, which may be one of the key reasons for crude’s spike. More recently, Enbridge, a Canadian oil firm, bought a 50% stake in a major pipeline that runs from the Gulf to Oklahoma. Enbridge announced that they would be reversing the flow of the pipeline, pushing oil through the $100/barrel mark for the first time in months. “The surprise announcement means that Canadian oil-sands production would be delivered to the Gulf Coast market, competing more directly with Brent-based barrels, wrote Tim Evans, an oil analyst with Citi Futures Perspective, in a note” writes Claudia Assis. To top it all off, recent supply reports have come in lower than expected, creating further tailwinds for the fossil fuel.

Since its dip to $75/barrel in early October, crude oil surged roughly 35%, nearly breaking even over the trailing six month period. Now that crude is surging, many traders are looking to buy in on down days and hop in on the trending commodity, but there are some factors that still need to be considered before investing [see also Commodity Trading Trends: Crude Oil In Focus].

Despite its recent tear, investors need to take a look behind the scenes before making an allocation to crude. For starters, crude tends to be heavily correlated to equities, as crude has featured a high correlation of 0.75 to the S&P 500 over the past year. Though crude has jumped quite a bit in the past few weeks, it has been overshadowed by equities that have done the same. The SPDR S&P 500 ETF (SPY) has jumped over 10% since oil hit its low, as October was one of the best months in recent memory for equities. One of the few reasons that oil has received so much attention as of late, on top of its performance, is simply because it broke through $100/barrel as well as the major Enbridge deal [see also Crude Oil Crushed: Buy or Sell?].

That all being said, equities are poised for a rocky future, as euro drama as well as our own budget haircuts threaten to wreak havoc on the recovery. If equities falter, crude oil will likely not be far behind. Though if we are able to pull out of this rut, look for crude to do the same. For those of you who have a strong opinion as to where crude oil or markets are heading, now may be a great time to establish a short or long position in a number of investments [see also Beyond UNG: Three Intruiging ETFs To Play Natural Gas]:

• Light Sweet Crude January 2012 (CL): This contract has the most volume of any current crude future, allowing for supreme liquidity and the ability to change a positions in a moment’s notice.
• United States Brent Oil Fund (BNO): This ETF tracks front month Brent oil futures on the ICE Futures Exchange, giving investors access to a different kind of crude.
• Exxon Mobil (XOM): While not a pure play, the world’s largest company can make for something of a safer play on the volatile commodity.

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Disclosure: No positions at time of writing.