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The Way You're Trading Oil Is Probably WrongBy Brian Hunt, editor in chief, Stansberry & AssociatesMonday, May 11, 2009 On March 12, I revealed what many people consider a bizarre way to speculate on higher oil prices:
Find the least-efficient oil companies in the world and buy them.
You see, most people try to trade the natural-resource sector by buying the best, most-efficient companies. They confuse the term "speculating" with "investing."
If you want to invest in oil, sure... buy a company like ExxonMobil or ConocoPhillips. These are the world's best and most-efficient oil producers... and they've both treated their shareholders to years of solid returns. These are wonderful stocks for "widows and orphans."
But for traders who want to speculate on oil, buying the biggest and the best isn't a great strategy.
As I explained in my DailyWealth column, if you want the biggest trading gains from higher oil prices, you want something with "juice." You want leverage. Leverage comes from owning the least-efficient oil producers in the business. Here is the example I provided:
Let's say oil is at $40 per barrel. We have two oil producers, ABC and XYZ. ABC's production costs are $10 per barrel... so it makes $30 of profit on every barrel it sells. XYZ's production costs are $30 per barrel... so it makes $10 of profit on every barrel.
If oil rises to $70, ABC's profit rises to $60 per barrel... an increase of 100%. Poor old inefficient XYZ, however, sees its profit per barrel increase 300% to $40 per barrel! XYZ stock will rise much more than ABC to reflect the profit explosion.
That's the power of "least efficient" leverage. And you'll find that power in the poster child of the Canadian oil sands, Suncor Energy (SU). Suncor is a favorite of mutual-fund investors. With a market cap of $30 billion, it's a large and liquid way to buy a stake in the oil-sands business.
Here's the thing about Suncor and its peers in the oil sands: You can't just stick a straw in the Canadian tundra and watch crude oil burst out like it does in the movies.
The oil is locked inside sand and muck… so companies have to dig it up with excavators the size of your house. They have to haul it to processing facilities with giant dump trucks. And then they have to put the stuff through a giant washing machine to produce clean crude oil.
All of this makes oil-sands production a very expensive process. Established oil-sand producers can spend three times as much as they would with a conventional oil well... much more than our "friends" in Saudi Arabia have to spend.
As you can see from the chart below, this "least efficient" idea has legs. Crude oil has crept up from $47 to $56 in the past two months. Most large oil producers are flat in the same time period. Meanwhile, Suncor is up nearly 30%.
 A trader's job is to develop an idea and then see if the market likes it. If it does, the trade makes money... If it does not, the trade loses money.
Right now, the market likes the least efficient oil producers. Suncor is making huge gains while larger oil companies have barely budged.
If you believe inflation is going to push oil prices even higher – and you want to make the biggest possible gains – the market is telling you where to place your bets.
Good trading,
Brian Hunt
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