MW_ArticlePageView
For the biggest profits, stay in oil
By
Euan Stuart
Jan 13, 2006
As bleary-eyed investors perused the investment columns at the turn of the year, they might have been excused for thinking that the widespread advice to take profits in the oil sector after its 40% rise in 2005 was a good idea.
After all, the 25% drop in the price of benchmark West Texas Intermediate crude since late October suggested that the peak was past, says BusinessWeek: even the attack on the US consulate in Saudi Arabia on 6 December barely made the many bears pause for thought. However, as it turns out, selling wasn’t quite the right thing to do. Already this year the oil price has hit a peak of more than $64, its highest level since 12 October and $5 a barrel higher than the price in late December.
So why the sudden change? Much of the recent rise in price is down to renewed tension in the Middle East, says Randy Fabi on Reuters. The latest worry is Iran – the world’s fourth-biggest crude exporter has broken UN seals on its nuclear testing plants, a move that may end up inviting sanctions from the rest of the world. At the same time, the New Year has not started well in Iraq, and Israeli prime minister Ariel Sharon’s medical problems mean that talks between his country and Palestine may well be delayed, something that doesn’t bode well for a peaceful atmosphere.
But the political tension surrounding the oil price is no longer just about the Middle East. It’s now about the Caucasus – where much of the West’s energy comes from – too. Last week’s decision by Russia’s president Putin to stop sending gas to Ukraine for four days came as a something of a shock to Europe’s energy importers, many of whom saw their gas flow slow as a result, but they’d better get used to Putin and his obvious power over the energy supply, says George Trefgarne in The Daily Telegraph. His next objective may be to create a sort of “Warsaw Energy Pact” from Russia’s sphere of influence in central Asia. If he did, and if it were to operate in the same sort of fashion as Opec has over the years, it would be “incredibly powerful” and its very existence would mean we should prepare for higher oil prices.
Shorter term, the weather isn’t helping the bears either. The US remains mild, but the rest of the world is in the grip of some very cold weather indeed. Asia – including Japan, the world’s number three oil consumer and a major user of kerosene for home heating – has recently been “buffeted” by record snowfall and freezing temperatures, says Fabi. China is in the grips of its coldest winter in 20 years, while New Delhi is seeing its lowest temperatures in 70 years. Some scientists think that a new cycle of supply-threatening “super storms” has begun.
Longer term, there will be no respite on the demand side either. With the fast-developing Bric (Brazil, Russia, India and China) economies showing little sign of slowing in 2006, demand can only keep rising. Consider what happens when a “sleepy village with no electricity” suddenly becomes “a bustling centre equipped with the comforts of modern life”, says Justice Little in Whiskey and Gunpowder. “Energy requirements increase by multiple orders of magnitude.” This is happening all over China and that means a “demand tidal wave” and, of course, fast-rising prices. The bad news is that this means “turbulent times ahead”. But on a brighter note it means that if you stay in the oil sector, you will find that “the biggest profits of all are yet to be made”.
The three best bets in the sector
For most people, the best way into the oil sector is through broadly invested unit trusts. The performance of the best known of these has been eye-watering: JP Morgan’s Natural Resources fund has returned 50% over 12 months and 280% over five years, while Investec’s one-year-old Global Energy fund has returned about 80%. But if the oil price keeps going up, so will they.
Those who prefer to invest in individual firms have a mass of highly speculative oil stocks to choose from, but we wonder if investing in these are worth the bother. As John Chatfeild-Roberts of Jupiter Asset Management says, the oil sector is an “oasis of cheapness”, even when it comes to the FTSE giants. BP (BP, 641p) and Shell (RDSA, 1,847p) together represent about a fifth of the Footsie index, and are obvious beneficiaries of the rising price of oil, yet both still trade on only low double-digit p/e ratios.
In the US, there’s no need to move beyond the giants either, says Standard & Poor’s Tina Vital in BusinessWeek. Most major integrated oil firms have single-digit p/e ratios, “rock-solid” balance sheets and healthy dividend yields. Vital likes Chevron Corp (CVX, $59), which has announced a $5bn stock buy-back, and Exxon Mobil Corp (XOM, $60), which has virtually no debt and “rewards investors” with ever-fatter dividends.
Published in Commodities
| More
articles
by
Euan Stuart
MW_RelatedArticlesFooter
MW_MoneyMorningSubscribeFooter.ascx
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Deputy Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.
