My Three Favorite Oil Investments Right Now

The Ford Motor Company taught my friend Michael an important lesson this year.

Michael is an old friend from North Carolina. He's a devoted husband and father, takes pride in his lawn, and goes to church every Sunday.

When it was time to buy a new truck, he decided to buy a big American-made, full-size Ford F-150. The truck came equipped for flex-fuel... which means it can burn E-85 ethanol (that's 85% ethanol and 15% gasoline), as well as regular gasoline.

Michael lives just outside Raleigh, North Carolina. There aren't many opportunities to buy E-85, but he found one little gas station that carries it.

Michael's new truck is also equipped with a computer that automatically calculates gas mileage. Imagine his surprise when he filled up with ethanol and found out that, although it's a bit cheaper, his gas mileage is terrible. Now he only buys E-85 if it is 70¢ per gallon cheaper.

The only perk he found from the ethanol was that his exhaust smelled really good.

In fact, Consumer Reports tested the fuel consumption of E-85 on a Chevy Tahoe. The result was a 25% decrease in fuel economy. That means you go as far on three-fourths of a tank of gas as you do on a full tank of E-85.

As it turns out, Michael's math is pretty close. When regular gasoline costs $3 per gallon, ethanol has to be cheaper than $2.25 for it to be worthwhile.

The truth of the matter is, ethanol is a political solution to the U.S. "energy problem." It's like strapping a helmet on someone about to jump off the Empire State Building. It isn't going to help, but you can honestly say you did something.

The problem is one of logistics. You can't simply declare ethanol the new fuel, without solving the plumbing too. The latest issue of the American Geological Institute's Geotimes confronts the problems of "Peak Ethanol."

Ethanol presents significant challenges – it corrodes pipes, absorbs water (which ruins gasoline), and eats rubber. These problems seem simple, until you have to retrofit an entire refinery with stainless steel pipes.

On a larger scale, ethanol raises more issues. For instance, how do you get ethanol from the Midwest to the East Coast? You can't put it into pipes for two reasons. First, the pipes aren't designed for ethanol and will corrode. Second, most pipes run north to south, not east to west, and there isn't enough capacity. That means you need to put it on trains and in trucks, which is not a solution either because it's too expensive. Not to mention the danger of a car accident with several thousand gallons of alcohol. We simply don't have the capacity to move huge volumes of ethanol.

The reality is, the oil problem has no easy solution. We aren't just addicted to oil; we're mainlining it. In the beginning, oil lubricated our economy. Gasoline and diesel fuel expanded America. It brought cheap goods to our far-flung inhabitants, and it was good.

Now that oil isn't cheap, attitudes are changing. However, changing attitudes won't alter the system anytime soon. We've built a giant infrastructure around automobiles – 70% of every barrel of oil we import goes to vehicle fuel.

I don't think we're going to wean our society off oil anytime soon. Wind, solar, and geothermal power generate electricity. They don't run your car (sorry all you electric car fans, the leap from prototype to showroom floor is still far away). And alternative fuels – like ethanol, biodiesel, and hydrogen – are flawed either from the start or still in laboratory bench trials.

From an investment perspective, this means you've got to have a portion of your portfolio in the oil sector. My three favorite oil investments right now are the Canadian oil sands, natural gas stocks, and oil services stocks. (Oil services stocks are the guys who supply the picks and shovels to the major oil companies.)

If you need to increase your exposure to oil, I suggest you start your research in these three investment areas.

Good investing,

Matt Badiali