What if Oil Drills Down Further?

The markets seem to factor in that oil is going back up to the $70 range. But what if the markets are wrong? Case in point: the S&P 500 is down 40% this year, and not too many people predicted that. So how does one profit off of the oil markets failing to realize that oil could drop to the $20 range?

We've all seen the adverse affects of oil skyrocketing to $147 a barrel and know how badly it affects the global economy. However, everyone was blaming speculators for driving up the price. Don't those same people now realize that speculators have driven down the price too? For every buyer of a contract of oil traded on the commodity's exchange, there's a seller too. So there must be more sellers than buyers right now.

Merrill Lynch (MER - commentary - Cramer's Take) predicts that oil will be $50 soon, but with a caveat: China could go into a recession, causing oil to drop to $25 a barrel. At $25 a barrel, most energy exploration could get shut down.

Most folks reading TheStreet.com don't trade commodities. They trade individual stocks. So we need a way to profit off of falling oil prices by following publicly traded companies.

According to a recent article in the Financial Times, it is profitable to develop the Canadian oil sands when oil is between $60 and $80 a barrel. So what if the price stays well below $60 for a long time? The oil sand producers will get hammered. Suncor (SU - commentary - Cramer's Take) and Petro-Canada (PCZ - commentary - Cramer's Take) should be on your radar screen should this scenario unfold.

What about Brazil and offshore exploration? This oil is expensive to drill for because it is miles under the surface of the ocean. A rig must be built and towed to the location. Oil must be between $30 and $60 to profitably recover. The deeper the oil, the higher the price oil must be. Watch Petroleo Brasileiro (PBR - commentary - Cramer's Take) -- it's the best way to invest in this area.

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At the time of publication, Osborne had no positions in the stocks mentioned.

Holmes R. Osborne III is a private money manager, founder of investment newsletter StockRoyalty.com and frequent author of financial columns. He has a degree in finance from the Martin J. Whitman School of Management at Syracuse University and is a CFA charter holder. Osborne is a member of the Pacific Council on International Relations, Malibu Rotary, Business Forum International and was formerly on the board of the L.A. National Association of Business Economists. He spoke this year at the fifth annual Value Investor Conference.