Crude oil prices spiked again Wednesday as Iran engaged in more sabre rattling with its European adversaries, furthering the risk of oil supply disruptions coming out of the Middle East.
Iran's state-run television news service said the country, one of the world's largest producers of crude, had cut exports to six European nations while other reports said Tehran had only issued ultimatums.
In any event, the price of Brent crude, traded in London, jumped more than 2% to US$119.99, its highest level since last summer. Brent's North American counterpart, West Texas Intermediate, touched a one-month high of US$102.54.
Higher prices would seem to be a boon for oil producers and their investors alike, because they generally benefit when prices go up. But not so fast: The pricing surge, which has been going on since the end of last year, has largely been for political, not fundamental reasons.
This leaves investors in a bit of a bind. They have to bank on increasing political tensions instead of actual supply and demand - a familiar position for gold bugs - for better returns.
"You look at the fundamentals, the economic demand for oil, [the price] should be lower, but it's not," said Benjamin Tal, deputy chief economist at CIBC World Markets. "A lot of it has to do with the political uncertainty in Iran. It's preventing prices from falling."
Mr. Tal said the political risk created by Iran's nuclear threats and the possibility of a western blockade or embargo of crude exports coming out of the Strait of Hormuz has added at least US$10 to crude prices.
If not for these issues, crude oil prices would be struggling because economic weakness in the United States, a probable recession in Europe and a manufacturing slowdown in China would combine to sap demand.
Inflated oil prices not supported by increased demand could also further harm the global economy, leading to more losses in all sectors.
"If prices aren't driven by demand, it could choke or create headwinds," said Charles St-Arnaud, an economist at Nomura Global Economics in New York. "If it goes to US$130, it can be a big negative to the economy."
Considering the current climate and risks, Mr. Tal suggests investors stay defensive on energy stocks for at least the next six months while waiting for improving economic indicators.
"Long term, I'm positive on oil prices. Look at it a year from now: The recession from Europe will likely be over, the United States will be stronger and China will likely have succeeded at its soft landing," he said.
Lanny Pendill, senior energy and utilities analyst at Edward Jones, said investors over the past year have been engaged in herd-like, "risk-on, risk-off" activity depending on the daily market headlines, but with a bias towards safer, less volatile stocks.
"Imperial Oil, Husky, Cenovus, high-quality, low-volatility stocks have done very well," he said. "If seeking value, we'd look at laggards of the prior year that have not done as well. The best value is now in the higher-risk categories: Suncor, Canadian Natural Resources, Nexen, Apache."
The reason is largely because of valuations, Mr. Pendill said. For example, Cenovus Energy Inc. has plenty of growth prospects, but it now trades at an expensive 22 times earnings after a strong year.
Suncor Energy Inc., which trades at 10 times earnings, is a far cheaper option for a company that is dominating the oil sands and has excellent growth prospects as well. "The difference is night and day," he said.
Mr. Pendill also prefers oil companies to natural gas companies. "Prices are really low, and a lot of these companies don't have deep pockets. Either they'll leverage to maintain production, or they cut production," he said.
Either way, it's bad news for investors, who generally prefer natural gas producers with good growth stories.
"Gas is bottoming, but there are still high gas inventories. We have seen a number of companies reducing spending levels in dry gas, which should lead to less supply," Mr. Pendill said. "I'm not sure if we'll see higher gas prices in 2012, but at least the industry is starting to take the right actions to make sure the North American market isn't so flooded."
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