- The Washington Times - Friday, March 12, 2010

OPINION/ANALYSIS:

Over the past several columns, I’ve been tracking economic data and discussing how it ties together. This week, let’s take a look at a ripple effect of an increasing commodity price and let’s use oil as an example.

I chose oil because of the perceived direct impact to consumer wallets in the form of gas prices but also because of the indirect impact on a number of items that people use or consume every day. I say indirect because oil can have many uses through a number of petrochemical formulations. Per the Paleontological Research Institution, petroleum-derived products include fertilizers, synthetic fibers, medicines that contain certain ingredients like acetylsalicylic acid and others, soapless detergents, such as powders and liquids used to wash clothes and dishes in a dishwasher, and a variety of everyday products.

In the past month, the price per barrel for crude oil spot has climbed from the $74-$75 level to $81.50 as I write this. Earlier this week, the Energy Department shared its view that oil prices would average $80 a barrel this spring and trend higher toward the end of the year. Simple math would say if oil prices average $77 in the first quarter of 2010, then to reach an average price of $80 for the entire year of 2010, oil prices are likely to at least hover near current levels in the short term and could trend higher later in the year. This upward movement predicted by the Energy Department reflects the expected rebound in the global economy in general and in particular expected robust growth in China. As always I try to keep price movement in perspective and as such we have to remember oil prices were around $41 per barrel this time last year.

Matching this up against data from the U.S. Energy Information Administration, we find that gasoline prices averaged $2.75 per gallon for the week ending March 8. While down substantially from the more than $4 that we paid at the pump in 2008, gasoline prices are up 42 percent from the average price of $1.94 per gallon this time last year. Think about this when we hear that retail sales are trending higher - strip out the impact of higher gasoline prices and consumer spending is not a bright as some would have you think.

The natural question as we exit winter and enter spring is: How high will gas prices go as we head into the summer driving season?

Well, the short answer is higher, but let’s try to put some rational behind how much higher. Over the 2005-2009 periods, U.S. gas prices rose an average of 29 percent from February to August; keep in mind that August tends to be the height of the summer driving season. To be fair, some years were slightly higher and some were lower hence using the average. Applying that 29 percent increase to the $2.64 that gas prices averaged this past February derives a potential price of $3.40 per gallon of gas. Again some perspective - that $3.40 prices equates to a potential 77 percent increase in the average price for a gallon of gas since February 2009.

Incorporating this part of the puzzle, my concern is the recent and any additional increase in oil prices and the flow through effect will have a negative impact on consumer spending particularly when we factor in current unemployment levels. This impact of higher gasoline prices could also crimp profit at those industries and companies that rely on oil and petroleum products to conduct their business - airlines, construction, transportation and so on. In other words, the direct and indirect impact of rising oil prices could crimp the burgeoning economic recovery here in the U.S.

As an investor, how do we hedge or protect ourselves from this to the extent we can? There are a few ways including buying the stocks of key beneficiaries of rising oil prices. This angle would include companies such as Exxon Mobil Corp., Chevron Corp., Royal Dutch Shell and ConocoPhillips, among others.

Another way to play the upward move would be to consider shares of fertilizer companies, which are also positioned to benefit from the rise of the new middle class as the global economic recovery continues. These companies would include PotashCorp, the Mosaic Co. and some others, but in here we need to be sure that these companies are more than able to offset rising raw material prices through a combination of incremental pricing for their products or cost reductions.

One of the newer ways to play this increase in oil prices would be buying shares in the United States Gasoline Fund LP, an exchange traded fund (ETF) that reflects changes in percentage terms of the spot price of gasoline. Another to examine is the United States Oil Fund LP, which is another ETF and mirrors changes in percentage terms of the spot price of light, sweet crude oil.

As always, I encourage all sorts of digging and questioning as you consider a new investment for your portfolio. Hopefully, we can make some lemonade out of the lemon that is rising oil and gas prices.

Chris Versace is director of research at Think 20/20 LLC, an independent research and corporate access firm based in Reston, Va. He can be reached at cversace@washingtontimes .com. At the time of publication, Mr. Versace had no positions in companies mentioned. However, positions can change.