Is it time to put your money in oil and gas?

The $70 oil barrel seems so far away, it could be coming back

By Charles Corvallis

The price of crude oil began the year by dropping like a stone, down 16% in the first couple of weeks of January. The plunge, combined with the fed's sudden withdrawal of income trusts, has had a sobering effect on the price of Canadian oil shares. The oil share index on the Toronto Stock Exchange (TSX) also dropped just over 16%.

The price of a barrel of oil has become so important that its declines significantly affect the value of the Canadian dollar. To understand just how sensitive the relationship is, you need only consider a single day — last Wednesday, January 17, 2007. That was the day on which winter finally came to the northeast in earnest. Analysts were convinced that the cold weather would cause a surge in demand for oil. Sure enough, the oil prices rose from close to $50US to $51.48 for February deliveries and the Canadian dollar rose from a near 13-month low of $0.8503US to $0.8524US.

"The commodity story is the key story for the Canadian dollar,'' notes Dustin Reid, a senior currency strategist at ABN Amro Inc in Chicago. Mr Reid expects to see a "slow and steady drop'' in the currency toward $0.835US. The Canadian dollar and crude oil prices have moved in the same direction 86% of the time over the past month, according to data from the financial news organization Bloomberg (www.bloomberg.com).

For the time being many currency analysts agree with Mr Reid and predict a declining dollar for the balance of the year. Others aren't so sure. Where you sit depends almost entirely on what you think may happen to oil and gold prices this year. Commodities account for 54% of our exports. Noting that oil and natural gas prices are historically at low levels at the beginning of the year, some analysts predict that prices will soon rise and continue to do so throughout 2007. The most optimistic suggest prices may reach $80 a barrel. Should that happen, natural gas prices could triple — all of which would do wonders for share prices.

OIL UP?
What would it take to see oil hit $80 this year?

• A decline in worldwide oil production. Though this is certain to happen in the long run, it's less certain that it will occur in the short term. In mid-January the Saudis announced they would not be reducing production despite the decline in prices.
• Continued escalating demand by China, India and other Asian countries. China currently consumes 500,000 barrels per day (bpd), against the 21 million bpd US habit, approximately 10% of which is supplied by Canada. It's worth noting that China is already investing in the Canadian oil and gas industry. Sinopic, the large Chinese firm, has a 40% interest in a joint venture on the Northern Lights project in Alberta, which is expected to produce 114,000 bpd by 2011. China is also interested in taking a 50% share of the Gateway Pipeline, which would carry crude oil from the Alberta tar sands to Kitimat, BC, for export. Though Washington takes a dim view of the project, the new trade agreement signed in Beijing in January suggests Ottawa doesn't feel the same way.
• The US dollar is expected to weaken, which would drive prices up.

Eighty-dollar barrels may seem unlikely, but even if the price goes to $60, investors who buy now will make substantial gains. The trusts are history but that history doesn't begin until 2011, plenty of time to benefit. Another significant enticement is the dividends some oil and gas producers offer. While some companies are using their substantially increased profits to buy back their stock, others have increased their dividends. Ask your broker about income producing firms: some companies have paid out as much as 18% — monthly.

MICROSOFT BACK
Speaking of dividends, another company to watch is Microsoft. Though it's unlikely to soon repeat the special dividend of $3 it paid out in 2005, the stock has begun to move on the launch of the new Vista operating system, the first in five years (see www.microsoft.com/canada/windowsvista/default.aspx for a look). The stock hit a 52-week high of $31.44US on January 16. One caveat: the software requires 1 GB of DRAM and runs best on Intel's new Core 2 Duo processor. New machines have been equipped with the necessary chips in anticipation of the launch but older machines simply don't have the power to run Vista and users may be reluctant to make the hardware upgrades necessary, which could slow sales.