Investments to watch when the oil price moves

Last week we looked at the four indicators which could help investors to spot turning points in the oil price (which is currently hovering around $46 a barrel, using Brent crude as a benchmark, just above its year lows). They were:

• US oil inventories
  
• US and global oil rig activity
  
• US shale oil output
  
• The oil futures markets and whether speculators are increasing or decreasing their long or short positions

To follow up, we will look at which instruments, sectors and stocks are most likely to be affected by any further drama in the oil price – up or down.

This column does not possess a crystal ball so it will make no foolish (and fruitless) attempt to guess where the oil price is going. Investors will have to follow the datapoints listed above as diligently as this author and then make up their own mind.

What is clear, however, is that oil stocks and oil equipment stocks are trading near their relative lows, compared to the UK stock market.

This can be assessed simply by dividing the value of the FTSE All-Share Oil & Gas Producers and FTSE All-Share Oil Equipment & Services sectors by the FTSE All Share.

If the oil-focused sectors are rising more quickly (or falling more slowly) then the line on the graph rises as they outperform the wider UK stock market – and vice versa.

As we can see here, the Oil & Gas Producers is trading near a relative level briefly seen in 2015-16 (when oil was slumping) and then before that in 2000 and 1998 – when oil was trading at $28 and $12 a barrel respectively.

Oil & Gas Producers sector is trading at levels seen in 1998 and 2000 (when oil was below $30 a barrel)

Source: Thomson Reuters Datastream

Oil Equipment & Services has a briefer history as it was only created as a sector in 2006.

Oil Equipment & Services sector is trading close to all-time lows on a relative basis

Source: Thomson Reuters Datastream

Nevertheless the chart shows two things:

• On a relative basis, the sector is trading only 15% above it all-time lows, on a relative basis
• The sector’s relative fortunes seem to slavishly track the oil price

If oil companies start to spend more on exploration then this group should benefit although one potential challenge is the growing efficiency of shale drilling and fracking techniques in the USA – figures from the US Energy Information Administration show that US shale production volumes are almost back to peak levels even if drillers are using barely half the past-peak number of rigs.

This column also accepts that relative performance is of little use to investors, who need profits and cash to pay the bills, not relative data.

But at least the charts suggest it may not take much to surprise on the upside and get the stocks going again, even if any further oil price weakness would still potentially hamper sector and individual companies’ share price performance:

Drilling down

There are a number of markets, sectors, stocks and instruments that could be directly influenced by changes in the oil price.

Investors might like to research them in the view they may do well if oil rallies or poorly if it sinks further.

• The UK stock market – passive funds

As frequently discussed in this column the big oil stocks (BP and Shell) are hugely influential across the entire UK stock market.

Between them they represent 13% of the FTSE 100’s market capitalisation, 13% of its forecast aggregate profits and 23% of consensus forecast aggregate dividend payments for 2017.

They are also forecast to generate a fifth of forecast profits growth and a tenth of forecast dividend growth, all on their own.

As such, the broader UK market is a potential beneficiary of higher oil and a potential sufferer it is slides lower.

BlackRock UK 100 Equity tracker is a fund and comes with an OCF of just 0.06%. BP and Shell both feature in its list of top five holdings with a combined weight in of around 9.6%. The total portfolio weighting to Energy stocks is 13.8%.

The SPDR FTSE All Share exchange-traded fund (ETF) performs the same function and also has top-five weightings in BP and Shell and a 12.1% weighting toward Energy overall.

• The UK stock market – active funds

As discussed last week a lot of the top performers in the UK Equity Income category have low weightings in the oils so they have a big decision to take, as to whether to jump back in or not. Their positions may influence investors as to whether the fund is right for them or not.

One fund which already has big holdings in both BP and Shell is Schroder UK Alpha Income, run by fund manager Matt Hudson. Shell is the single largest position and BP comes second, representing more than 10% of the fund’s assets between them.

Martin Cholwil’s Royal London UK Equity Income fund has Shell as its largest holding and BP is the fifth biggest position.

• Energy-themed fund

One passive option to research here is the ETFS US Energy Infrastructure ETF.

Listed on the London Stock Exchange, this tracker is designed to provide the performance of a basket of more than 20 American energy pipeline, storage and logistics firms, a lot of whose share prices have fallen hard alongside the actual oil price, even if it is volume which drives their business, not price.

The tracker offers a dividend yield above 5.5% and could rally if oil makes sustained gains (or wobble if not).

Do note that tracker uses synthetic replication to provide performance, so it does not own the stocks which form the underlying Solactive US Energy Infrastructure MLP Index but a wide range of collateral assets which are used as part of a derivative agreement with an investment bank. Actual holdings include French and Belgian Government debt and listed stocks.

An active fund that specialises in the area is Guinness Global Energy, where Shell and BP are among the top three holdings, but the UK represents just 12% of the assets, compared to 46% for the USA and 15% for Canada.

Passive and active funds can offer exposure to oil-related firms

Source: Thomson Reuters Datastream

• Oil tracker

Investors may want to avoid stock specific risk and just follow the oil price.

ETFS Crude Oil ETC tracks the US benchmark, West Texas Intermediate, and ETFS Brent Crude the equivalent European oil benchmark.

Note that both trackers follow a basket of oil futures prices, not the spot price, and both use synthetic replication (derivatives) to achieve this. Besides movements in the oil futures, investors are also exposed to the roll yield and collateral yield for their total return on investment.

• Oil stocks

According to the London Stock Exchange’s own website there are 98 oil and gas producers and explorers listed on the Main Market and AIM with a combined value of £270 billion, ranging from Magnolia Petroleum Oil’s market cap of £1.4 million to Shell’s at £172 billion.

BP and Shell will generally respond favourably to the higher oil price as the higher crude goes the safer their fat dividend yields become. The lower oil goes the harder they will have to work to fund their dividend, to the potential detriment of their share prices.

Both stocks offer earnings cover for their dividends of barely one times in 2017 when a ratio of at least two times is ideal. They are both selling assets and cutting investment, while they could also borrow to fund the pay-out but over the long term all three of those could do more harm than good and the best and most reliable dividends are paid out of profits and cash flow.

FTSE 100, FTSE 250 and FTSE Small Cap oil stocks and their valuations

Source: Digital Look, consensus analyst forecasts

Less well developed, pure play producers like FTSE 250 firms Cairn and Tullow could also benefit, but the operational and exploration risks are higher here.

Then the riskiest oil plays are the AIM-quoted junior explorers which may not even be producing or have a find, but whose share prices could welcome more positive sentiment toward their industry.

• Oil equipment stocks

The London Stock Exchange is host to more than a dozen firms which provide equipment and services to the oil industry.

None of them feature in the FTSE 100, although Wood, Petrofac and Amec Foster Wheeler were all once part of the UK’s elite index. Other names to note include Lamprell, Cape and Hunting, although do note they all have different client, geographic and product exposures. Wood has just launched a bid for Amec Foster Wheeler.

Russ Mould, AJ Bell Investment Director