Five slick ways to play oil

“Oil traders may have seen President Trump’s decision to withdraw the US from the 2015 nuclear sanctions coming from some distance away but confirmation of the move and American plans to exclude OPEC’s third-biggest producer* from global markets is still giving a fresh lift to the price of crude,” says AJ Bell Investment Director Russ Mould.

“Investors do need to keep an eye on the price of oil, which is now up 50% year-on-year.

“A sustained surge in crude could lead to inflation or even a slowdown in global economic activity, given the potential impact on consumers’ spending power (mainly due to higher fuel and petrol prices) and corporate margins (owing to an increase in input costs).

“History suggests that it is only when oil prices have doubled year-on-year that global growth really starts to feel the pinch. The price spikes of 1974, 1979, 1990 and 1999 all served to usher in recessions and a near-doubling in crude in 2008 may not have helped matters then either, while even the rapid rise in summer 1987 will conjure up memories of stock market chaos.

“Thankfully, we do not face anything like the oil price shock of the early 1970s, which ushered in a wretched period of stagflation (and a lost decade for almost every asset class except gold). Investors will be also encouraged by how very brief periods of a doubling in oil in 2010 and early 2017 did not derail the global economy but the higher oil goes and the more dangerous the impact of the Trump policy shift could become.

Five ways to play a rising oil price

“For those investors who think OPEC and Russia will stick to their production cuts and that Iranian output will be excluded from global markets, to provide sustained gains in the price of oil, there are plenty of ways to get involved, albeit with varying degrees of risk profile.”

1. Dedicated energy equity fund

There are a select number of actively-managed funds which specialise in investing in firms related to the energy industry and oil equipment and services stocks in particular. Guinness Global Energy is one example. Just under half of its assets are in US-listed stocks with 15% in Canada and 8% in the UK. The largest individual stocks positions include Canadian oil sands specialist Suncor, American oil giant ConocoPhillips and Italian producer ENI.

Another option to consider here is the ETF Solutions ETFS US Energy Infrastructure MLP exchange-traded fund (ETF). Listed on the London Stock Exchange, this tracker is designed to provide the performance of a basket of 25 American energy pipeline, storage and logistics firms, a lot of whose share prices have fallen hard alongside the actual oil price. The tracker is SIPP and ISA eligible and comes with a total expense ratio of 0.25%. Many of the individually quoted stocks within the basket come with juicy dividend yields which could be supported or enhanced if oil makes sustained gains. Do note that tracker uses synthetic replication to provide performance, so it does not own the 25 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.

2. UK equity tracker fund

The iShares Core FTSE 100 exchange-traded fund is big (£5.8 billion in assets), cheap (0.07% total expense ratio) and has both BP and Shell in its top-five holdings list, with an overall weighting toward energy of 17.1%, although it is by no means a pure play.

3. Actively managed UK equity fund

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. One fund which already has big holdings in both BP and Shell is River & Mercantile UK Equity Income. They are the two single biggest holdings in the £286 million collective, which comes with a 15% weighting toward energy, a 3.7% dividend yield and a 0.90% ongoing charge.

4. Oil tracker

Investors may want to avoid stock specific risk and just follow the oil price. ETFS Commodity Securities ETFS WTI Crude Oil tracks the US benchmark, West Texas Intermediate, and ETFS Commodity Securities 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.

5. Oil stocks and oil-related stocks

Oil stocks have yet to fully warm to the rise in crude prices, as if to suggest investors do not believe the gains will last.

The FTSE All-Share Oil & Gas Producers sector has gained just 4.4% in 2018 (to rank it 13th out of the 39 industry groupings which make up the FTSE All-Share) while the Oil Equipment & Services sector is up by just 0.9%, to place it in 20th in the performance rankings.

Also note how the FTSE All-Share Oil & Gas Producers index trades at a multi-year low relative to the oil price (a calculation achieved by simply dividing the index’s value by the oil price).

The index currently trades at 128 times the actual oil price, compared to an average of 156 over the last 20 years:

Source: Thomson Reuters Datastream

BP and Shell are the biggest members of the sector index and they will generally respond favourably to the higher oil price as the higher crude goes the safer their fat dividend yields become – both offer earnings cover of 1.1 times (BP) to 1.3 (Shell) times in 2018 when a ratio of at least two times is ideal.

However, cash flow is improving fast and this means the dividend is now far less reliant on selling assets or raising debt, both of which looked like they would have to be a major contributor when oil hit $30 in 2015, even if neither could be relied upon as a long-term solution.

Based on an unchanged dividend per share of $0.40 from BP and $1.88 from Shell (and a sterling-dollar exchange rate of $1.3530) BP currently offers a 2018 dividend yield of 5.3% and Shell 5.2%.

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.

The London Stock Exchange is also host to a select number of firms which provide equipment and services to the oil industry. None of them feature in the FTSE 100, although Wood and Petrofac were both once part of the UK’s elite index. Other names to note include Lamprell and Hunting, although do note they all have different client, geographic and product exposures. Wood has just completed a bid for industry rival Amec Foster Wheeler.

*Global oil output Q1 2018:

Source: OPEC Monthly oil market report, April 2018

These articles are for information purposes only and are not a personal recommendation or advice.