How Your Portfolio Can Profit From Higher Oil Prices

Feeling the pain of skyrocketing oil prices? Even though oil hit $106 a barrel this week, analysts at Standard & Poor's expect it to keep rising in the short term.

The political unrest and revolution in Libya are sparking the current price spike, but additional factors -- such as a growing world population, the industrialization of India and China and the surging ranks of the middle class in emerging markets -- will also keep demand high as supplies tighten worldwide. That will boost oil prices over the next year, according to S&P mutual fund analyst Michael Souers.

"We've got oil supplies threatened or potentially threatened at a time when demand is potentially increasing," says S&P equity analyst Stewart Glickman, who covers oil services and drilling. "The geopolitical risk has been contained for some time, but now people feel that it may not be contained."

Glickman says it's also getting increasingly harder for oil companies to find new supplies. As the capacity of known oil fields diminishes each year, that leaves the riskiest and most expensive fields left to drill. For example, deepwater drilling permits in the Gulf of Mexico are more expensive and come with added safety costs, especially after BP's (BP) catastrophic Deepwater Horizon explosion and oil spill last year.

All of these factors mean oil could remain pricey for a long time, but at the very least, they suggest further upward pressure on oil prices in the short term. Analysts have already targeted $120-a-barrel oil as a major milestone, but some are suggesting that even $200 oil may not be far off.

Pain Relief for Oil-Price-Pressured Portfolios

But higher oil prices aren't necessarily all bad news for investors: They also can create new opportunities. Investors might be able to find some pain relief for their portfolios with investments that benefit from oil's steady increase.

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For example, investing in oil-industry-related mutual funds could be an excellent play "over the next 12 months and beyond," Souers says.

Unless you have the financial resources to buy expensive-oil company stocks like Exxon/Mobil (XOM) or Chevron (CVX) directly, mutual funds and exchange-traded funds (ETFs) that track oil-related industries are worth considering. They're much less expensive, and they offer greater diversification and lower risk than investing in individual stocks -- although they also might deliver less of a reward when oil prices rise.

But mutual fund analyst Dylan Cathers advises investors to make sure that one fund doesn't make up their entire portfolio exposure to energy or the oil industry. Each fund may have different levels of exposure to different parts of those industries. "It's important for investors to know exactly what they are looking for and to look at their own funds," he says.

Taking Advantage of Oil's Predicted Rise

As for ETFs, the United States Oil Fund ETF (USO) tracks oil exclusively, Glickman says. Other energy ETFs that track indexes that are heavily weighted toward oil-related industries include the $10 billion Energy Select Sector SPDR Fund (XLE), the $2 billion Vanguard Energy Index Fund ETF (VDE) and the $1.1 billion iShares Dow Jones Energy Sector Index Fund (IYE).

"ETFs can give you exposure to the integrated oil and gas companies, upstream exploration and production companies and oil equipment and services firms," Glickman says. "You may have to trade some performance on oil-price gains for hedging exposure to other parts of the industry."

S&P recommends several funds based on performance, risk and cost. These include:

Fidelity Select Portfolio Natural Resources Fund (FNARX)
Has outperformed peers over the one-year, three-year and five-year periods with a low expense ratio of 0.9%. Top holdings include Exxon/Mobil, Apache (APA) and Massey Energy (MEE).

Franklyn Natural Resources Fund (FRNRX)
Has outperformed peers over the one-year, three-year and five-year periods with a 1.1% expense ratio. Unfortunately, it carries a sales load of 5.75%, which adds to the expense. Top holdings include Schlumberger (SLB), Chevron and Exxon/Mobil.

ICON Energy Fund (ICENX)
Has outperformed peers over the three-year period by 400 basis points with a 1.2% expense ratio. Has a higher turnover rate than its peers, which can increase overall fund costs due to trading fees. Top holdings include Exxon/Mobil, Apache and Chevron.

ING Global Natural Resources (LEXMX)
Has outperformed peers over the one-year, three-year and five-year periods by 400 basis points. Invests in a wider array of companies – 45% of the assets are invested in foreign stocks. A sales load makes it a bit expensive. Top holdings include Exxon/Mobil, Schluberger, ConocoPhillips (COP)

Guinness Atkinson Global Energy Fund (GAGEX)
Has outperformed peers over the one-year and three-year periods with a 1.4% expense ratio. Provides an equally weighted approach to energy industry. Top holdings include Chesapeake Energy (CHK), BP and PetroChina (PTR).

Vangauard Energy Fund Admiral (VGELX)
Has more exposure to integrated oil companies than most mutual funds. Very low costs with an expense ratio of 0.32%. Top holdings include Exxon/Mobil, Chevron, Total (TOT) and BP.