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Oil’s well with Shell in a jittery world

The Independent: Private Investor: Oil’s well with Shell in a jittery world

Saturday 13 August 2005

By Sean O’Grady
Published: 13 August 2005

It’s all very worrying. Terror. Record oil prices. The Bank of England warning about lower growth and hinting at higher interest rates. Our streets about to become cesspits of drunken yobs. Oh dear.

Strange then that the stock market is looking so chirpy, relatively speaking. Just like oil, the FTSE 100 has been setting a few records of its own lately, putting in its best numbers since 9/11. This actually follows earlier stonking performances by the mid-cap indices. I thought that it would only be a matter of time before the blue chips caught up, and for a change I managed to get that particular prediction right.

It’s all even stranger if you take the view that profitability is bound to be squeezed by current events. Oil always grabbed the headlines, but most commodities have seen a pretty remarkable inflation in the past couple of years, and sooner or later this is bound to feed through into input prices. Against that, there is every sign that consumer spending is slowing down, the housing market is at last calming itself and there is that indication from the Bank and the gilt markets that medium-term rates are on the up. Don’t forget that it only takes a relatively small hike in rates, say up to 6 per cent or so, to see new mortgages increasing many hundreds of pounds a month, with all that implies for disposable income and spending. And once the economy starts into a downward spiral like that it’s difficult to will confidence back again. The real trigger usually comes with a rise in unemployment.

The only thing that really makes the average Brit stop spending money like it was going out of fashion is the news or a rumour that a friend or acquaintance is about to be lose their job.

Terrified yet? Well, it is a grim outlook. Yet there are reasons to be cheerful for investors. First, the economy isn’t half as dependent as it used to be on oil for growth. There have been a few articles on this in the press, and I confess I can’t remember the exact numbers, but we used to consume an awful lot more energy per £1 of national product before the oil shocks of the 1970s than we do now. Second, oil is still cheaper in real terms than it was in the 1980s. Third, the rise in rates may be quite gentle and spread over years, so we may have more chance to absorb them than with some monetary shocks in the past. Fourth, whatever happens there are always secular growth stocks that will prosper come what may, and there’s always abroad and there’s oil itself.

Which is why I’m pleased that I stuck with my investment in Royal Dutch Shell, adding when the shares hit particular weakness about four years ago. My shares were in fact in the old Shell Transport and Trading Arm of the former group. Now that its complicated and arcane structure has been rationalised, we shareholders have been given a one-off technical boost because of the new higher weighting the firm has in the FTSE index, so prompting all those tracking funds to buy some more.

Then there’s the process of reform after the great Shell reserves scandal, itself not such a massive blow as the City thought at the time. Third, there’s the rise in the oil price. Now that “downstream” refining and manufacturing activities (making chemicals, plastics, textiles) have been downgraded, Shell is much more of a pure play on the oil price itself. I started buying Shell when oil was $10 a barrel because I simply couldn’t believe that that price was remotely sustainable. Now we know.

I suppose the question now is whether a $60 or $65 barrel is sustainable. Even when the short-term factors affecting the price, such as the threat to Saudi Arabia and the summer closedown of some US refineries, work themselves through we all know, don’t we, that the price is going to be around these levels for some time. For we all also know that it takes time to develop new fields and that the world is now paying, in part, for the underinvestment the oil companies were forced into in the heady days of the $10 barrel back in the late 1990s.

Sadly, the terrorists are not going to go away and the world has become a much more jittery place. It isn’t a world that many of us much like, and I would rather that things were different. But one of the few things we can do is to make provision for that, and that is why I’ve bought more Shell at 1874p. I’m sure they and oil have further to go. Don’t have nightmares.

s.o’[email protected]

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