As I highlighted in the last issue of The Energy Strategist, Super Oil, oil prices have been rising during the past few months largely because of a tight supply/demand balance. Demand has remained robust worldwide despite higher prices; inventories in the developed world have been falling as the Organization for Petroleum Exporting Countries (OPEC) has maintained its discipline.

I went on to state that I expected oil prices to begin to moderate sometime in the new year as OPEC inevitably stepped up output and a slowing global economy started to crimp demand. The indicator I watch to determine OPEC’s discipline is simple: tanker rates.

Remember that tanker rates aren’t leveraged to oil prices; they’re leveraged to demand for moving oil. When OPEC keeps supplies constrained, oil prices tend to rise but tanker rates fall simply because less oil is getting shipped from the Middle East. This is why tanker rates, and to some extent tanker stocks, remained weak throughout the third quarter and into the fourth quarter of this year.

But that’s all changing, and I sense a chill wind blowing for crude oil prices in the next few months. The Baltic Dirty Index of tanker rates has spiked 20 to 30 percent since the beginning of last week. And tanker stocks have followed suit, rising sharply alongside rates.

This suggests that OPEC is finally starting to ship crude in earnest; I expect this to start showing up in oil inventories sometime in the first quarter of 2008. That trend will put downward pressure on crude oil prices. I wouldn’t be surprised to see oil break into the $70s or even upper $60s depending on the severity of the global slowdown.  

It’s important to remember that this doesn’t spell an end to the energy bull market. In fact, I’ll be looking to recommend some of my longtime favorites in the oil services and equipment arena in such a pullback. And other nonoil segments of the energy markets can rally even if crude falls.

How to Play It

First, defend yourself. Make sure that you follow my advice on stop losses and sales; these moves will allow you to hold on to gains and ride out any correction. Also, check out my recommended short in Halliburton, detailed in Flash Alert: Shorting Halliburton.

Second, buy tankers. I hold General Maritime (NYSE: GMR) in the Proven Reserves Portfolio. I continually get questions on this one and am often asked why I bother recommending tanker stocks when they’re “down” so much over the past few years.

This is a common misconception. Tanker stocks pay enormous dividends. To calculate returns, you must factor in both the price of the stock and the value of dividends received.

To account for all of this and avoid confusion, I’ve adjusted the Entry Price column in the Portfolio tables to reflect dividends paid since I recommended General Maritime. On a total-return basis, the stock is actually up nicely. General Maritime rates a buy.

For a more leveraged play on tankers, consider Frontline (NYSE: FRO). This stock has more leverage than General Maritime to rising tanker rates because of its heavy exposure to the spot tanker market. I’m adding Frontline to the Gushers Portfolio as a buy under 47, with a stop loss at 39.90.

Finally, as a hedge against potential downside in crude oil, I recommend purchasing the UltraShort Oil & Gas ProShares (NYSE: DUG). This exchange traded fund (ETF) shows performance equal to the inverse of the Dow Jones Oil & Gas Index. In other words, the ETF rises when oil- and gas-related stocks pull back.

I see this as a useful hedge against short-term downside in the energy patch. I’m adding UltraShort Oil & Gas ProShares to the Wildcatters Portfolio as a buy under 47, with a stop at 38.90.