Serious Money/Chris Johns:   Oil prices are back in the headlines, with the cost of some types of crude back to levels last seen at the start of each of the Gulf wars.

Oil prices at these levels have almost always been followed by a global recession or, at the very least, a major slowdown. The only exception seems to have been the spike in prices at the start of the most recent war.

At the start of 2003, the global economy was only just emerging from a slowdown, itself associated with the rise in oil prices that occurred earlier in 2000, and looked robust enough to weather what appeared to be only a temporary, second Gulf war, hike in oil prices. Were those judgments about the oil price and the world economy a touch premature? If so, the investment implications will be profound.

Forecasting oil prices is about as easy as forecasting exchange rates. Anybody with any skill in either area should simply become commodity or foreign exchange traders.

One of the most famous forecasting errors in history was when the Economist suggested, in March 1999, that oil prices would fall to $5 per barrel ($5bl). They had just collapsed to $10bl and many people echoed the Economist's views.

Since then, prices have averaged $27bl.

Once again, the oil price has confounded most experts and is higher than anyone anticipated. Indeed, people who are paid the most money to get the oil price right, the analysts who cover oil-producing companies, have again been far too pessimistic.

Many of those analysts base their valuations of oil companies on a long term oil price assumption of around $18-$20bl. Even a $1bl rise in these long-term forecasts produces quite dramatic gearing effects on the profitability of many oil companies. A simple tactic for anyone who thinks that the oil price is likely to stay high for the foreseeable future is to buy the shares of oil companies.

Oil prices are high because demand for oil has been surprisingly strong; OPEC has been more cohesive than in recent years; and there have been some high-profile cuts in proven reserves, most notably by the Anglo-Dutch giant, Shell. Continued instability in the Middle East has also been an obvious influence.

If these factors combine to produce higher-than-expected oil prices we might need to think about more than the relatively simple consequences for oil company profits.

We might be tempted to think that if the oil price is strong because the world economy is growing rapidly, high oil prices will sow the seeds of their own destruction because of their effects on global growth. While there is some substance to this argument, I wouldn't push it too hard.

Much of the marginal increase in oil demand is coming out of Asia, particularly China, and looks to be pretty permanent. Thus, a secularly higher oil price may be more immune to the vagaries of growth cycles, particularly in the West.

That does not mean that our economies will be unaffected by high oil prices. Far from it. If energy prices stay where they are for much longer we can expect growth forecasts to start to be scaled back.

Stock markets are trying to anticipate this and there is a traditional sector rotation taking place, away from more cyclical areas of the market towards defensive stocks.

But in a declining market there are very few places to hide; losing money at a slower rate is still losing money.

In Europe, high oil prices have to some extent been offset by the stronger euro. Nevertheless, this is the region that I would expect to be hardest hit by sustained strength in energy costs, not least because euroland simply lacks the institutional flexibility to respond appropriately to external shocks.

Stock markets have flirted with the idea that the European consumer might start to spend again but all such thoughts are rapidly being discarded.

Investors can choose to make a big bet and drastically reduce their holdings of equities as a result of all these concerns.

If a less apocalyptic view of the future is adopted, but one that still embraces the reality of higher energy costs, then an investment strategy that avoids heavy consumers of oil in favour of oil producers should obviously be considered. The oil sector looks attractive in this regard.

If crude oil stays anywhere near current levels, many oil companies will be made to look fabulously profitable - or, more importantly, more profitable than the market seems currently to think.

It is always tricky trying to work out what the market is discounting but it looks like investors are still trying to factor in a rapid and steep fall in oil prices.

Comparing one or two traditional valuation measures with current oil sector profitability strongly suggests that something is out of line: either the market believes that existing profitability is unsustainable or something else, like higher interest rates, is around the corner.

Oil companies have had a bad press latetly, with management upheaval at Shell over unexpected downgrades to proven oil reserves. It is at times like these that the slightly contrarian investor should look at a sector that appears to offer good value.