From the rise of Hugo Chavez’s socialist ideology in oil-rich Venezuela to Vladimir Putin’s reassertion of the Kremlin’s control of Russia’s resources, along with increasing political influence by China in Africa, geopolitics now plays the central role in determining predictions for hydrocarbon supply constraints, which feed into the sector’s price movements.

While fundamentals of supply and demand still apply, their equilibrium has been obliterated by the impact of global instability on the supply side. Although some events are unpredictable, the vast majority of the pressure being brought upon supply is the result of calculated moves that producers use to manipulate prices—and bludgeon oil-thirsty importing nations. As Fadel Gheit, a New York–based oil and gas equities analyst with investment firm Oppenheimer, says: "Oil is the political weapon of the day."

Consequently, a number of analysts predict severe supply restrictions in the future. "Due to political conditions in a number of key oil reserve holders, we’re seeing a cap on the production levels that we can expect to see going forward," says Saad Rahim, Washington-based analyst with PFC Energy, a consulting firm. PFC reports that political factors are limiting production capacity in six key producer countries: Venezuela, Iran, Iraq, Mexico, Kuwait and Russia. Against the grim reality of this volatility, investors in the energy sector face a dilemma: Even if prices generally trend upward, should they ride the waves of volatility and profit in the short term, or is it wiser to adopt a buy-and-hold strategy for the longer term? Furthermore, what are the best ways to take strategic exposures?

The Short Term
When trying to answer these questions, investors should start with a thorough analysis of the underlying factors that are likely to affect expectations of future supply and demand. These will ultimately move prices.

Chronic political instability is leading to underinvestment in production capabilities and therefore undersupply.

As recently as seven years ago, traditional supply-and-demand criteria such as seasonality, weather, inventory levels and supply restrictions primarily drove market price. Beneath the growing shadow of geopolitics, these factors remain intact and still affect prices. Traditional supply-side restrictions, meanwhile, are not difficult to understand. These are typically found in shortages of refining and storage capacity as a result of underinvestment or from seasonal maintenance of refineries, which cuts their productivity. Investors can find reams of data on these issues. Short-term traders should look to the International Energy Agency, the U.S. Department of Energy and other organizations to keep them well informed with such timely data and forecasts.

But now that security issues play a much larger role in movements of oil and gas prices, investors are riding them correspondingly, and finding it more difficult to take a short-term view on the market. They find it impossible to predict when the next geopolitical event will roil prices. Those investors who want to speculate on hydrocarbon prices in the very short term can always buy futures via a broker. The brave souls who take this route, however, should be supremely confident that they have the pulse of the market and a true feel for when prices are about to move. A new pronouncement from the International Atomic Energy Agency regarding Iran’s attempts to acquire nuclear technology, for example, is very likely to move prices, as it did in May. But what are the chances of investors getting in quickly enough to take advantage of a subsequent price correction? Another way to take direct exposure to oil prices is via the United States Oil Fund exchange-traded fund, which trades on the American Stock Exchange and gives a pure play on the price of West Texas intermediate oil.

The Long Term
Without a doubt, investing longer term in the energy sector reflects a more prudent play. Investors wishing to take exposure for the long term could invest directly in some of the oil majors, such as ExxonMobil and British Petroleum (which have generated their own headlines lately by announcing record profits). Such investments, however, require careful analysis of individual company performance, estimates of likely future performance and, of course, of concentrated risk in one of these corporations.

Probably the easiest way to take broad, long-term exposure is through a fund, a number of which take managed exposure to companies operating in the oil and gas industries. The ING Risk Managed Natural Resources Fund, for one, seeks total return through a combination of current income, capital gains and capital appreciation, according to ING. Under normal market conditions, the fund seeks to achieve its objective by investing at least 80 percent of its managed assets in the equity securities of, or derivatives linked to the equity securities of, companies that are primarily engaged in owning or developing energy, other natural resources and basic materials, or supplying goods and services to such companies. A well-chosen manager could outperform the underlying market against which he is benchmarked.

These managers have one ace in their pockets: Geopolitical volatility will remain a constant for the foreseeable future. This day-to-day volatility could, perversely, make long-term plays the most predictable of all. Indeed, some market observers note that chronic political instability is leading to underinvestment in production capabilities and, therefore, undersupply, which creates opportunities. "Each country has a different story, but the common feeling is that the investment climate is not very hospitable, and, as a result, the multinational oil companies that have the expertise and the technology are pretty reluctant to go into these places," says Gal Luft, director at the Institute for the Analysis of Global Security in Washington, D.C.

John Ferry is an Edinburgh, Scotland–based financial journalist and a senior correspondent for Worth.