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The Observer: The high price of investing in oil’s future

The Observer: The high price of investing in oil’s future

Heather Connon

Sunday July 24, 2005

The oil price has risen more than 50 per cent over the past year and almost six-fold since the lows of the late Nineties, and some experts predict that it will double by the end of the decade. But, for most of us, the only way we are exposed to soaring oil prices is through higher prices of everything from petrol to heating oil.

Buying barrels of oil and storing them in your cellar is hardly an option and, while some commodity funds will have exposure to oil, they will also invest in metal, gold and other resources, which will affect their performance. Firms such as Cantor Index and IG Index also offer oil futures, betting contracts or warrants, but these are for professionals, rather than retail investors, according to Cantor’s David Buick, as their price depends as much on political and economic factors as on the oil price.

On Thursday, that will all change. A company called Oil Securities Limited will list on the London Stock Exchange and its price will directly reflect changes in the oil price – or, technically, the one-month futures oil contract which is the instrument behind the quoted oil price.

Structured as an open-ended company, new securities will be created as buying orders are received, or cancelled as they are sold. Citigroup and UBS will be the market-makers for the product, although you should be able to buy it through your local stockbroker.

Investors will be able to chose between two shares: Brent Oil Securities will reflect the price of Brent Crude, while WTI Oil Securities will track the price of the WTI Contract traded on Nymex in New York. The share price will be equal to the price of one barrel, in dollars – the universal currency for the oil market.

The one complication is that futures contracts expire on a particular date – the current one-month contract, for example, will expire in August – so Oil Securities’ prices have to move to a new month’s contract ahead of the expiry of the old one. That will usually be at a different price, so the number of barrels your share entitles you to will be adjusted accordingly. If, for example, the share is priced at $60 but the next forward contract is trading at $66 – in practice, such a big variation is unlikely – the number of barrels underlying the share would fall by about 9 per cent.

When new shares are issued, Oil Securities will buy a matching oil contract from Shell, which has agreed to provide contracts for up to 40 million barrels of oil – equal to a market value of around $2.3 billion (£1.3bn) at current oil prices. Graham Tuckwell, chairman of Oil Securities, says the backing of a major oil company gives investors comfort and, if demand is greater than the amount initially agreed, it could approach other companies to supply it.

The structure is similar to Gold Bullion Securities, brought to the market by the same management team as Oil Securities, which tracks the gold price. That has already raised $3.3bn, $800 million of that in London and the rest in New York and Australia. The gold price has risen strongly since the shares were launched, although returns to British investors have been diluted by weakening of the dollar.

Currency is, of course, one of the risks for anyone buying shares in Oil Securities: it is unlikely that the exchange rate will be the same when you want to sell your shares as when you bought them. There is also a risk that the experts have got it wrong and oil is not on its way up to $120 a barrel, but down to $20 a barrel.

There are plenty of reasons for expecting the price to continue to rise: it is a scarce resource and finding a new supply is difficult and expensive; and demand is rising across the world but particularly in China, where both manufacturers and increasingly affluent consumers are using more and more fuel. If China continues to grow at current rates many more of its 1.3 billion population will, want gas-guzzling cars, fridges and air-conditioning units. But it is also possible that the price will fall if the global economy slows or the Chinese miracle runs out of steam.

A share in Oil Securities should be bought only as part of a balanced portfolio of investments: putting all your savings into one commodity is far too risky.

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