The Oil Factor: Protect Yourself and Profit from the Coming EnergyCrisis

The most important events in history, the ones that will have the greatest impact on our lives for years to come, often slip by unnoticed at the time. Go to a library and scan issues of the New York Times from the fall of 1960. What was making news in that presidential election year, apart from coverage of the Kennedys' glamour and Nixon's five-o'clock shadow? Two tiny islands called Quemoy and Matsu; and Nikita Khrushchev; and our fledgling space program.
Definitely not grabbing headlines, in an era when oil was priced at under $2 a barrel and the U.S. satisfied around 70 percent of its oil needs through domestic production, was the decision, in September 1960, by five countries-Iran, Iraq, Saudi Arabia, Kuwait, and Venezuela-to form a loose coalition called the Organization of Petroleum Exporting States, or OPEC. But the ultimate repercussions of that event have been massive. In fact, as we will detail below, it is no exaggeration to say that OPEC, which gradually expanded to include Qatar, Indonesia, Libya, the United Arab Emirates, Algeria, Nigeria, and Ecuador, has become the single most important determinant of the health, or lack thereof, of both our economy and our financial markets.
Ten years later, another oil-related economic milestone also got little attention. In 1970, U.S. domestic oil production, which up until then had been consistently rising, embarked on a decline, one that has continued ever since. To the extent that anyone noticed it at all, it was viewed as either a temporary anomaly or as simply no big ?.deal. Like the formation of OPEC, however, the decline in domestic oil production has been of critical importance to the economy and to investors.
Oil is key to all we do, to every facet of our economy. Or to put it more precisely, energy is key, and for now, because of a long-term failure spanning administrations of both parties to develop alternative energies, energy means oil. Our need for oil, our growing appetite for this critical resource, is the prism through which it is essential to view all that is happening in the world today and all that will occur tomorrow. This is true for all of us, citizens in general. And it is true in an even more specific way for investors who want to understand what is likely to happen in the financial markets in coming years and what they need to do to protect themselves and profit.
Above all, it's essential for investors to grasp, intellectually and viscerally, the following realities:
For the last thirty years, the price of oil has been the single most important determinant of the economy and the stock market. Sharp rises in oil prices have been deadly for the economy and the stock market, while steady or declining prices, or even prices that increase only gradually, have led to good times. For investors, it's what we dub your "desert island, one phone call" indicator. If you can know only one thing about the world, make it the direction of oil prices over the preceding year, and you'll do better in the stock market than almost anyone else following any other indicator, from interest rates to corporate profits. This has been true for the last three decades, and it will remain true throughout the early part of this century-until we kick our oil habit and develop and switch to viable energy alternatives.
Oil prices are a determinant over which, for the past thirty years, we have more or less ceded control. In other words, through good times and bad, we have exercised little real control over our own economic fate.
Finally, the situation is about to shift from bad but acceptable to worse, because, as we'll detail in chapter 3, for all practical purposes the world is running out of economically extractable oil. This puts us more than ever at the mercy of the very few nations with significant untapped reserves-Saudi Arabia and to a lesser extent Iraq, Iran, and Kuwait. Over the long term it's clear that the only viable solution is to free ourselves from our dependence on oil entirely, by shifting to other forms of energy. But in the meantime, we are trapped in a tricky and dangerous present, in which we need to ensure that we have the oil we need to keep the economy going while we seek to develop alternatives on a meaningful scale. This doesn't mean that the economy is doomed or that there aren't significant profits to be made in the stock market during the tumultuous transition that lies ahead. It does mean, though, that you have to know what to look for-in particular, that you need to watch oil, tracking the direction of oil prices at any given time and then tailoring your investments to fit what oil dictates.