"We are running out of oil. The world economy will collapse and wars will be fought over remaining supplies." Such is the hysteria that gets investors excited about the limitless prospects of investing in oil. My colleague Ivan Martchev explains why buying based on this scenario won't do your portfolio any favors. -- Neil

Turbulence in Oil's Air Pocket

By Ivan Martchev

Don't get me wrong. I do believe in the long-term story for oil. But forgetting about "here and now" cost investors a lot of money in 2008 and could do so again.

The United States consumes 25 barrels of oil per capita, while other industrialized but more efficient countries like Japan and Korea consume about 15-16 barrels of oil per capita. In the history of the world, every time a country industrializes, it uses more oil.

Do you know what the oil stats are for China and India? China consumes roughly two barrels of oil per capita, while India consumes 0.9. And they both have more than a billion people, they are growing fast and their oil consumption is growing too. No one can tell you how high their per capita consumption will get, but I am certain that eventually it will double, triple and quadruple from the present level.

The question is...When? Should retired investors be speculating with oil service stocks or other leveraged oil stocks? The answer here is probably no, or at least not to the degree that many did last year.

In the Long Run We are All Dead?

Many years ago, Keynes astutely observed the pitfalls of looking too far ahead. The experience from 2008 suggests that one cannot invest blindly in long-term stories even when they are credible: 70-80% haircuts in leveraged oil stocks are impossible to stomach.

Oil has rallied a lot in 2009. In February oil was trading below $40 and recently it has traded above $80. Many oil stocks have doubled and tripled and many experts say it is going higher. I don't think is so. Here is why:

The western world economies are quite weak. They have stabilized courtesy of government stimulus spending, but consumers are not in good shape. When the stimulus spending runs out next year, I don't believe that consumers will pick up the slack, which will lead to another economic downturn, affecting export-driven economies in Asia. Thus, chasing leveraged oil stocks that have rallied a lot already is not advisable.

There is always the risk that the US or Israel will attempt to eliminate Iran's nuclear capabilities. In that case, oil would go higher - but do you want to bet money on it? If such a move does not come, there is more downside than upside in oil from current levels over the next 6-12 months.

Oil Investments That Work Right Now

I won't repeat too much of what my friend Neil George has told you on many occasions, but in the present environment, stocks that pay you dividends work here better than those that don't. His September 4th issue Petrol Prices Plunge But You Still Profit profiled 4 investments that work regardless of the level of oil and gas prices: Linn Energy (NSDQ: LINE), Enterprise Products Partners (NYSE: EPD), Sunoco Logistics (NYSE: SXL) and Teekay LNG (NYSE: TGP).

While the first three were well explained by Neil, I also want to mention that Teekay LNG Partners actually owns ships - mostly LNG carriers, but other vessels also - and leases them under very long-term (15+ year) contracts. Thus, the company takes on little risk while the rest of the shipping industry is not in good shape. A good example of the latter is Frontline (NYSE: FRO) which is barely holding up as it relies on short-term contracts, while Teekay LNG has recouped all of last year's losses.

The decline last year in Teekay LNG's stock was completely irrational as the company was reporting improvements in operational performance, yet the stock was cut by more than half. This is one well stress-tested dividend.

How NOT to Buy Oil

Whatever you do, don't buy and hold the US Oil Fund (NYSE: USO), the oil futures ETF that currently trades at about half the price of oil. This ETF is guaranteed to lose you money as it rolls over futures positions every month.

When the ETF first began to trade, the shares were priced at par with the price of oil. Now they are almost $40 lower, due to the roll loss that happened every month that the expiring futures contract was lower priced than the next month's - which has been the case for most of the life of the oil ETF. For short-term trading this roll risk is immaterial, so the ETF does serve a valuable purpose, but buy and hold investors will get badly burned if they use it improperly.

Oil Buys for the Long Haul

If you don't mind the wild swings in oil prices and you want to buy a stock that will do well in your grandchild's account, consider Petrobras (NYSE: PBR). They own huge oilfields that are uneconomical at today's prices. The company needs $175 billion in the next five years to develop fields that are miles below sea level. No one knows how much really it would cost to develop this oil, but the current guesstimate is well above the current oil price.

Still, the Chinese loaned Petrobras $10 billion, so they must think that someday this oil will be valuable. I would not advocate Petrobras shares for retired investors, but your grandchildren will likely benefit from owning this stock.

For the US majors, the highest leverage to the oil price belongs to ConocoPhillips (NYSE: COP), which is why the stock declined the most over the past year compared to ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX). Conoco also has the best reserve replacement strategy of all three, while Exxon's reserve replacement strategy is worrisome. Conoco is another one for the grandkids; but stay away from Exxon.