A Perfect Storm for Oil Prices

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Oil prices rose more last week than they had in any week since September.

That was partially due to strong economic news – both here in the U.S. and abroad. U.S. GDP growth came in at 3.3% in the fourth quarter, and perhaps more importantly, China is trying to stimulate growth by loosening requirements on banks.

Meanwhile, U.S. oil production fell by 1 million barrels per day last week due to bad weather, and inventories dropped by more than 9 million barrels.

And OPEC still plans to cut production by 2.2 million barrels per day throughout the first quarter of this year.

So with demand rising and supply tightening, it’s no surprise that oil prices were strong last week.

In the February issue of The Oxford Income Letter, which comes out on Tuesday, February 13, the concept of supply and demand is an important focus.

This relationship is the basis for most markets. If more people want a particular stock, the price will go up. The same is true with commodities. If demand is rising while supply is falling, those who own the commodity can (and will) charge more for it when they sell it.

That simple idea is the main reason I’m so bullish on energy.

Solid growth in the U.S. certainly helps, but the booming middle class is an even bigger catalyst. Between 2023 and 2030, 1 billion people will join the middle class worldwide.

That’s a lot of people buying gasoline, electronics, items made of plastics, and many other products and services – all of which require energy in order to be produced, transported, used and disposed of.

It’s hard to imagine a world where energy demand will not grow over the long term.

I’m bullish on pretty much all energy sectors – oil, gas, renewables, nuclear, etc. – as they will all play a role in satisfying the planet’s unquenchable thirst for energy.

But I’m particularly enamored with oil stocks right now.

After years of oil producers having a “grow at any cost” mentality, investors are now holding them accountable to be wiser about their spending. Their shareholders are demanding that they prioritize dividends and stock buybacks over wasteful projects that don’t produce cash flow.

The mammoth oil companies are safe bets to do well in the future, and they usually pay decent dividends. But the smaller, independent oil producers are especially attractive. As long as they’re cash flow positive, they’re prime candidates to be acquired by bigger companies, which still need to grow but usually don’t want to start digging new holes.

A company like Occidental Petroleum (NYSE: OXY), which has a $51 billion market cap, is small enough to be swallowed up by the “majors” with market caps in the hundreds of billions. “Oxy Pete,” as it’s affectionately known, is a favorite of Warren Buffett’s. The legendary investor bought more shares in December and now owns 28% of the company.

As oil prices rise, stocks like Occidental Petroleum should do extremely well. If you don’t have enough exposure to the energy sector, consider adding some energy plays to your portfolio today.

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