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The Times: Profit from the rising price of oil

The Times: Profit from the rising price of oil

 

May 02, 2004

 

With the price of crude near a 13-year high, Alicia Wyllie asks the experts for tips on the best way to take advantage

 

SHARES in oil firms are set to beat the market this year as political uncertainty and tight supply send fuel prices soaring.

 

Companies such as Shell and BP, which make up 11.7% of the FTSE All-Share index, performed poorly during 2003, rising just 8.7% against 20.9% for the index as a whole. They lagged the market despite growing demand in China, which pushed shares of other commodities up 37.6%.  

 

Hilary Cook of Barclays Stockbrokers said: “Oil shares were unsettled by uncertainty over the recovery in the global economy. The oil price, an important influence on company profits, was also volatile, falling from $33 a barrel at the start of the year to $23 a year ago before rising to $27 in September.”

 

Shares in Shell also dropped as the company was forced to admit it had overstated its reserves. The troubles at Shell dragged down the performance of the sector.

 

But oil shares have bounced back. Since the start of April the sector has leapt 7.8% against 3.4% for the FTSE All-Share and a drop of 5.6% for the mining sector. The bounce has been fuelled by a rise in the oil price to $34.68 a barrel — it came close to a 13-year high last week. A 17% increase in first-quarter profits at BP also boosted oil stocks.

 

Experts think the strong performance is likely to continue as oil prices are expected to remain high, and could even reach $40 a barrel by the end of the year.

 

Kevin Norrish at Barclays Capital, an investment bank, said: “Oil prices usually drop at this time of year as the weather improves, but that is not happening. The political situation is worsening in Iraq and there are potential supply problems in Russia, Nigeria and Indonesia.”

 

The Opec oil cartel cut production last month and hinted that it might increase its target price range of $22 to $28 a barrel by at least $4.

 

The downside of rising oil prices could be a slowdown in the global economy. As prices move higher, companies’ production costs rise, which eventually feeds through to higher prices and boosts inflation. If interest rates then increase, it could drive the world economy back into recession.

 

Investors can get exposure to the oil sector either by buying shares in oil companies, through investment funds, or by betting on the oil price.

 

Shares

 

The UK oil sector is dominated by two companies — Shell and BP. Cook said: “BP announced strong profits last week. It is definitely a safer bet than Shell.” Shares in BP closed at 487½p on Friday.

 

But other experts back Shell. Jeremy Batstone of Fyshe Horton Finney, a stockbroker, said: “Despite the row over the overstatement of its reserves, Shell is a robust company and this setback could present a buying opportunity. I think the shares could go up 10% from here.” The shares are trading at 389p.

 

The smaller oil companies are also worth considering. Duncan Goodwin of Merrill Lynch, an investment bank, said: “Cairn Energy has announced a third successful exploration well in Rajasthan in India, which has encouraged us to raise our target price to £11 a share.” Shares in Cairn cost £10.74.

 

Funds

 

If you buy a FTSE All-Share tracker, 11.7% of your assets will be invested in oil shares. M&G’s Index Tracker fund is the cheapest, with no upfront fee and an annual management charge of just 0.3%.

 

But a tracker will only produce returns in line with the stock market. If you think oil stocks have the potential to do better, you need to buy a fund that has a greater exposure to that sector.

 

Mick Gilligan, fund analyst at Killik, another stockbroker, said: “There is only one fund that gives you pure exposure to the oil sector — the Investec Global Energy fund. This scheme is an offshore fund, but it is recognised by UK regulators and has a strong management team. We are happy to recommend it.”

 

An alternative is to buy a commodities fund. Both Gilligan and Darius McDermott of Chelsea Financial Services, an adviser, back JPMF Natural Resources. This fund, however, only has 25% of its portfolio in oil stocks. McDermott also likes M&G Global Basics (see Fundwatch).

 

Gilligan suggests Artemis UK Smaller Companies and Framlington UK Select Opportunities. He said: “These funds both have talented managers who currently hold big positions in the oil sector.”

 

If you want exposure to the global oil sector, it is worth considering an international fund, or one that focuses on an oil-producing country, such as the JPMF Russian Securities investment trust. But McDermott said: “Investing in a single sector or individual emerging market is high risk and only suited to the more adventurous investor. If you want to hedge your bets you may be better off investing in a broadly based fund, such as the New Star Global Growth Portfolio.”  

 

Betting on the oil price

 

If you are brave, you can speculate on a rise, or fall, in the oil price using spread betting. Specialist spread betting firms such as IG Index or Finspreads will quote you a price for oil on a particular date in the future. You can then bet on whether you think the price will be higher or lower.

 

Last week, for example, IG Index was quoting a price for July Nymex Crude of $36.85. If you thought the price would move higher you could “buy” and make money if the price went up at any point before July, or “sell” if you thought the price would move lower.

 

You don’t need big sums to spread bet — IG Index, for example, has a minimum bet of £1. An added bonus is that all your profits will be free of capital-gains and income tax.

 

Alternatively, you can buy a covered warrant on oil. Covered warrants, which were launched in Britain in 2002, enable investors to profit from both rises and falls in the price of a range of assets, such as commodities and shares. You can also use them as an insurance policy on your portfolio or to gear up your exposure to a particular market.

 

If, for example, you believe that the oil price is set to bounce, you could buy a covered warrant that gives you 10 times its gain. So, if the price were to rise 10%, your investment would rise 100%.

 

Covered warrants are issued by investment banks such as JP Morgan and Goldman Sachs and are traded through stockbrokers. Trading covered warrants should be no more expensive than buying and selling ordinary shares.

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