Here's Why Oil Is So Expensive

NEW YORK (TheStreet) -- Increasingly, a long U.S. Natural Gas ETF (UNG) and/or short U.S. Oil ETF (USO) position is appearing attractive. I often trade both, along with their options.

Like all ETFs, UNG and USO have inescapable administration and transaction costs eating away at longer-term returns. With the use of options, I am able to mitigate risk and take advantage of time decay. When I position into UNG, I either sell covered calls or write put options. My risk is lower and my odds of success are greater.

Holding a UNG/USO position will likely feel much like taking the summer family vacation with three young sons, like I do. I am already expecting the question, "Are we there yet?", to cause an involuntary twitch in my face by the end of this summer's trip. Similarly, low natural gas prices are not going to cause a drop in oil prices without taking some time.

Natural gas prices are so low, new planning for drilling and exploration have all but halted. Meanwhile, gas and diesel prices remain near $4 a gallon throughout most of the country.

In my view, $100+ oil is unrealistic, and Saudi's efforts to maintain a price of $100 will be a challenge. I believe front month West Texas Intermediate is more likely to trade near the $50-$70 per barrel range within a year to 18 months.

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The three biggest markets for oil are shifting in both supply and consumption.

Europe

Starting with Europe, where oil trades at a relatively new premium compared to North America, we may see the divergence close soon. Overall, I believe the European economy is sinking further into the abyss rather than climbing out.

The United Kingdom is staring directly into the face of a double-dip recession. While oil and natural gas consumption has remained steady, production has declined. The U.K. is now a net energy importer instead of exporter. At the same time, the U.K. debt is climbing fast and will have to be brought down soon, one way or another.

These two events are related, in my view, because the U.K. has overspent with various government programs based on the ability to export oil. What the money was spent on, and the politics involved, are beyond the scope of this article.

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