share tip, investing in oil, Tim Price

Share tip of the week: ignore analysts and theorists, just buy oil

20.07.2007

by Tim Price

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MoneyWeek readers should be well aware of the oil equation by now: secular underinvestment + significant global demand growth led, not least, by Asia + dwindling supplies = bull market. Luckily for UK readers, the London Stock Exchange is home to some of the world’s biggest oil majors, so while the core crude price is denominated in US dollars (although not, perhaps, forever), UK shareholders can avoid currency risk, at least as far as these companies’ share prices are concerned.

Royal Dutch Shell (RDSB.LN), tipped as a BUY by Deutsche Bank

Deutsche Bank has just raised its recommendation for Royal Dutch Shell from ‘hold’ to ‘buy’ in the belief that the long-term crude price may average more than $45 a barrel. “Our mid-cycle oil price estimate of $45 a barrel is now looking more like a long-run floor,” said Lucas Herrmann, Jonathan Copus and Christyan Malek. “The risks at this time seem very heavily skewed to the upside.”

I agree. While theorists continue to debate the ‘Hubbert peak oil’ thesis, investors should take a more straightforward approach: forget the theory, respect the price action. From a low of just over $51 in mid-January, Brent crude futures rose to more than $80 a barrel this week – a record high. The geopolitical backdrop also supports higher prices. Supply fears have played a part (Chevron and ConocoPhillips said the closure of the North Sea’s Central Area Transmission System gas pipeline would hit oil production at two fields), but markets this week were also buzzing with rumours that US vice-president Dick Cheney is urging the Bush government to authorise military action against Iran. Whatever that might do to the Middle East, it’s unlikely to hurt oil prices.

Deutsche Bank raised its price target for Shell from £19.25 to £23.75. This partly reflects its rerating of the oil sector from a p/e multiple of ten to 11 times 2008 earnings to a revised multiple of 13. This is still untaxing compared with the overall market – the FTSE 100 trades on 14 times current earnings and 13 times prospective earnings. Exxon Mobil, now a $500bn firm by market capitalisation, enjoys a comparable rating: 13 times 2007 and 2008 earnings.

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As befits its size (its current market capitalisation is £133bn), Shell is well followed by the City – 38 brokers cover the stock. Of these, 20 rate it a ‘buy’ (including Deutsche Bank), 14 a ‘hold’ and there are just four ‘sell’ recommendations from Oddo & Cie, Goldman Sachs, Raymond James, and Teather & Greenwood. But the City has long had a rather schizophrenic view of the oil sector, and City oil forecasts aren’t known for their accuracy. Goldman Sachs cut Shell from ‘neutral’ to ‘sell’ because it faces “three years of heavy investment in its new legacy assets without the prospect of material production growth”. Goldman pointed to likely cost overruns, notably the Eni SpA-operated Kashagan oil field in Kazakhstan. That looks overly bearish to me, as long as the oil price stays in its recent $50+ range. With a dividend yield of 3.3% offering reasonable income, Shell merits a place in any diversified portfolio.

Recommendation: BUY at 2,070p

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