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How to cash in from rising oil price

The Independent: The Investment Column: How to cash in from rising oil price

Edited by Stephen Foley

11 August 2004

Should the private investor reshuffle his or her portfolio of shares in response to the seemingly inexorable rise of the oil price? What, if anything, ought to be added, what avoided?

The main message should be: don’t panic. This is no Seventies-style oil shock. Although in nominal terms oil prices are now as high as they were in 1978, in real terms – adjusting for inflation – they are still substantially lower.

Opec has given mixed signals over how much capacity it has to increase production. Storms in the Gulf of Mexico, turmoil in the Persian Gulf and political meddling in Russia have all stoked fears that supply will fail to meet demand. But these are only fears so far, and the record oil prices reflect speculators betting on disruption as much as any real shortages. Most of the major oil companies have big increases in capacity planned over the coming years, so the oil price is likely to drift lower over the medium term.

In the short term, though, investors should be more cautious in examining companies where fuel costs are a big expense. Only this week, British Airways warned that its fuel bill will rise by £225m this year to £1.14bn. For airlines, rising fuel costs are only one element in the investment mix. Others are: the scope for cost savings (running out and running into employee resistence at BA, and nil in the first place at the low-cost carriers); demand for air travel (rising over the long term, but not immediately now that consumers are under pressure to cut borrowing); and price competition (still ferocious). Airline stocks should be avoided for now.

Though they will debate by how much, economists agree that higher oil prices crimp global growth. The disappointing outlook for 2005 has already hit equity markets and economically sensitive shares, but investors should still sell their holdings in companies which face the double whammy of lower demand and rising oil-related costs. Chemicals companies such as ICI, Yule Catto and British Vita are among those which will find it hard to pass on rising costs to their customers.

Money that has to go into the petrol tank is money that cannot be spent on luxuries such as new clothes and expensive holidays, so investors wanting consumer-focused shares should seek out companies growing their market shares, such as Next, or selling basics, such as Tesco.

The Investment Column is a fan of BP and the current high oil price is a bonus which will be passed almost wholly to shareholders through share buy-backs. It is a buy, but Shell is still only a hold since its shares have already risen to fully reflect the higher oil prices. Don’t forget BHP Billiton, the mining conglomerate, also gets one-third of its profits from oil and gas.

And here is one other unusual potential winner: BAE Systems, the aerospace contractor, which has a wide-ranging arms deal with Saudi Arabia, where payments and the quantity of orders placed by the government are related to the oil price.

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