Pumped up: the winners and losers from dearer oil

The Independent: Pumped up: the winners and losers from dearer oil

15 May 2004

If the cost of oil remains high, the knock-on effects will be serious and wide-ranging, says Jenne Mannion

Oil companies such as BP are obvious beneficiaries of the surging crude oil price, but there are far more stock market losers than winners. The crude oil price has touched around $40 (£22.60) a barrel in recent weeks, its highest point since October 1990, when Iraq invaded Kuwait. This recent spike represents a 22 per cent increase this year.

Joe O’Donnell, a private client stockbroker at BWD Rensburg, says: “The higher oil price is good news for oil companies but bad news for almost everybody else.”

Higher oil prices have a three-pronged effect on the economy. The immediate impact is the higher prices at the petrol pumps, coupled with more expensive heating bills, leaving consumers with less disposable cash. Consumers therefore spend less on goods and services and companies feel the pinch on profits, which are already under pressure because their raw material costs have surged.

Ultimately, the rising oil price pushes up inflation as businesses increase their costs. To keep this in check, central banks respond by increasing interest rates. Certainly, the higher oil price, combined with fears of interest rate rises, led to jitters in global stock markets this week.

While the oil price has a detrimental effect on the broader market, there are some sectors that will benefit or suffer more than others.

THE LOSERS

Airline companies are among those to feel the high oil price pinch particularly hard given their high usage of jet fuel, which has risen in cost by 58 per cent in the last 12 months.

Analysts at Goldman Sachs this month reduced their earnings forecast for British Airways and SAS Group, the Nordic region’s biggest carrier, citing increased fuel costs. Dresdner Kleinwort Wasserstein also downgraded its earnings forecasts for BA.

Graham Campbell, a fund manager at the investment boutique Edinburgh Partners, says: “Airline companies sell their tickets in advance, yet aviation fuel prices have gone through the roof. This will have a negative impact.”

Indeed, the rising fuel price has contributed to recent profit warnings from the budget airline easyJet. This was just the latest in a series of blows from the budget airline sector. In January the Dublin-based carrier Ryanair delivered its first profit warning, and this month the Birmingham-based budget airline Duo went into receivership.

Some airline companies are endeavouring to mitigate the effects of the rising fuel prices by passing on the costs to customers. BA has imposed a ticket surcharge of £5 on round-trip fares sold in the UK. In markets outside the UK a $4 surcharge is being added. Australian-based Qantas has adopted a similar strategy; but low-cost airlines say they have no plans to impose additional fees.

While most investment professionals are negative on airlines because of the higher fuel prices, there is a flip side to this coin, according to Graham Ashby, a fund manager at DWS Investments. “Some airlines look quite attractive on a valuation basis. We are looking at easyJet, for example, as the share price has fallen substantially following the recent profit warning,” he says.

General transport stocks will also feel the pinch. Mr Campbell says companies such as Exel, which is involved in air freight and contract distribution, will likely see its profits suffer from higher distribution costs.

A less direct effect is that companies which rely on consumer spending will feel the pain of higher oil prices as disposable income dries up, says Mr Campbell. Those that will suffer most include consumer-oriented stocks such as leisure and hotel companies, and retail outlets. “Companies like Dixons, the high street electronic retailer, will clearly struggle if customers are not spending,” he says.

THE WINNERS

The obvious winners from the high oil price are oil and gas companies, such as BP and Shell, and smaller stocks such as Cairn Energy. Over the year to 10 May, the FTSE Oil & Gas index has gained 6.25 per cent, while the broader FTSE All Share index has fallen by 0.28 per cent over the same period.

Although Shell has been mired in controversy for overstating its reserves, both it and BP have announced share buy-back programmes over the year to return surplus cash, resulting from the higher oil price, to shareholders.

Mr O’Donnell says a higher oil price will translate into higher revenue for the oil stocks, even if volumes remain flat. As much of their cost base is fixed this increase in revenue should lead to further rises in the share price, he adds. “As such, both of the UK oil majors, BP and Shell, should benefit from a sustained high oil price,” he says.

While direct oil stocks have been the clear winners, investment professionals say there are hidden gems to be found in associated industries such as exploration and production, and companies that service oil firms. Mr Ashby explains: “These companies enjoy the knock-on effect of cash-flushed oil suppliers.” One such stock is Rotork, an engineering firm that supplies safety equipment to oil companies.

Mr O’Donnell says BG is also an obvious beneficiary. “BG is more exposed to the exploration and production side of the oil market than the majors, and should be a more geared play on any sustained strength,” he says. “Another stock worth considering is BHP Billiton. Although predominately a mining company, around 30 per cent of its profits come from oil exploration and production.”

Robert Waugh, head of UK equities at Scottish Widows, says that, if the oil price remains high, the profits of exploration companies such as Expro International, Abbot and John Wood Group will also soar. “There would be a lot more exploration and development if the high oil price was sustained,” he says. Mr Waugh however believes the oil price will fall below $30 within the next 12 months.

A less obvious beneficiary is the packaging company Bunzl. Ironically, this company uses a large amount of fuel in its manufacturing process, but is able to pass the cost on to the customer. “Bunzl is the dominant paper and packaging manufacturer for supermarkets and hence enjoys strong pricing power. Packaging companies obviously use oils to make the plastic, but because Bunzl has a strong market position, it can pass those price increases on to customers,” Mr Ashby says.

Another stock in the same situation is Croda International, Mr Ashby says. This holds a group of companies that manufacture a diverse range of chemicals and chemical products for the pharmaceutical, personal care, food processing and plastics industry.

“You would assume that chemical companies would feel the squeeze as oil prices rise, but this is not necessarily the case. In Croda International’s case there is such a shortage of capacity that they have been able to pass on the fuel price increases,” he says.

John Hatherly, head of strategy at M&G, says higher oil prices could, less directly, lead to risk aversion in the market. “A sustained higher oil price will change the attitude to risk. Over the last year or so as equity markets have recovered, the perceived risk of recession, deflation and lower profits has diminished. The higher oil price could lead to a change in this view. Investors may look to a more risk-averse strategy move into stocks considered to be more defensive, such as utilities and beverages,” he says.

IS DOOMSDAY HERE YET?

Although it is widely conceded that oil prices above $50 would tip the world into recession, few fear the worst-case scenario.

John Hatherly says: “The mistake people are making is to assume that the oil price is going to go bounding away up to $50. It may succumb to some of the downward pressures that are being put on metal prices at the moment. China, for example, is the world’s second-biggest user of oil and the government is making efforts to slow down the rapid growth in this country.”

He says that parallels with 1990, when the oil price last soared and led to a global downturn, the economy is now in good shape.

“The economic background is much stronger than in the early 1990s – the worst you can expect is for the higher oil prices to shade the rise in economic activity slightly, rather than push the world into recession,” he says.

Mr Hatherly says that in the UK, while petrol prices have risen, this is against a backdrop of soaring house prices, low unemployment and high consumer confidence. “It’s going to take more than higher fuel prices to depress this mood,” he says.

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