We may live in the oil age, yet surprisingly few people directly invest in this remarkable commodity.
Oil fuels and feeds the world. It gives us petrol, plastics, petrochemicals, solvents, asphalt, paint, fertiliser and feedstock, and household goods such as shampoo, perfume, cosmetics and deodorant.
A horse would have to work for one full year to produce the energy in a single barrel of oil. A young, fit human would have to labour for 10 years.
There’s a reason they call it black gold. But is it a good investment?
Oil can be shockingly volatile. In July 2008, for example, the price of a barrel of Brent crude soared to US$146, arguably triggering that autumn’s global stock market crash, but by December that year it had sunk to just $40.
The oil price has been relatively stable in the past few years, but now it is on the move again.
“Since 2011 the oil price has fluctuated between $90 and $130, and volatility has been low,” says Aksel Kibar, a CMT technical strategist at Invest AD in Abu Dhabi.
That could soon change. “Oil price volatility is cyclical, it can’t remain low for long. Periods of low volatility are typically followed by high volatility, and vice versa,” Mr Kibar says
The oil price peaked at $116 in June, largely because of political turmoil in the major oil producers Iraq and Russia, but the possibility of fresh supply from Libya and the US shale oil boom has eased the pressure.
Traders who anticipated that oil prices would rise on today’s political turmoils been proved wrong, says Chris Beauchamp, a market analyst at the global trading service IG. “Weeks have gone by and oil supplies have been relatively unaffected.”
On the morning of August 8, West Texas Intermediate futures for September delivery were trading at $98.12 a barrel and Brent crude for September was at $106.53 a barrel.
Traders have learnt to take bad news in stride, and this suggests the oil price could fall further, Mr Beauchamp says.
Other analysts disagree. Oil is just too important for the price to fall much lower, says Steen Jakobsen, the chief economist at the global investment bank Saxo Bank, which has offices in Abu Dhabi. “Everything you did this morning involved energy consumption. Checking your smartphone, putting on the coffee, pouring cold milk from the fridge, taking a shower, driving to work and walking into your air-conditioned office.”
Oil is primarily extracted from volatile or underdeveloped regions, creating a real risk of disruption of supply. If current geopolitical threats in the Middle East and Russia continue, it is a safe bet that energy prices will rise, Mr Jakobsen says.
Most serious investors should have some exposure to commodities in their portfolios, says Matthew Michael, a product manager on the commodities team at the asset managers Schroders.
But you should brace yourself for a bumpy ride. “Oil prices may have risen over the past 15 years, but the journey has not been smooth. If you had invested in Brent crude oil futures in 2007, for example, you would have enjoyed a 49 per cent return that year. In 2008, you would have suffered a 53 per cent loss. In 2009, you would have made 29 per cent.”
Schroders has a “positive outlook” for energy, including crude oil. “Climate change, supply shocks and rising demand from emerging countries should drive commodity prices higher. The question all investors should ask is how can they protect their purchasing power in this challenging environment. Oil is part of the answer.”
Mr Michael says you should also balance this with other commodities, such as gas, precious metals and agriculture, to offset the inevitable oil price volatility.
So how do you invest in black gold?
Exchange traded funds.
If you are feeling brave, you could invest directly in oil futures, says Mr Kibar at Invest AD. “But you should only do this if you are an experienced, disciplined investor, because the possibility of losing your capital is high.”
For most people, an ETF is a better way to invest in oil. These are low-cost index-tracking funds that follow the fortunes of a host of markets, indexes and commodities, and can be traded quickly and cheaply like individual company stocks.
You can use ETFs to invest directly in the oil price, Mr Kibar says. “Oil ETFs don’t actually physically buy oil and gas, that’s prohibitively expensive. Instead, they gain exposure to price movements by investing in near-term futures contracts.”
This can make them more volatile, so more cautious investors may prefer to buy an ETF that invests in the stocks of oil companies and the wider oil-services sector.
These have the added advantage of generating dividend income on top of growth.
Jason Webster from Fleming Family & Partners, the manager of the VAM commodities fund, recommends two ETFs investing in oil company stocks. “The SPDR S&P Oil & Gas Exploration & Production ETF gives you exposure to smaller, more dynamic companies that are likely to be more reactive to changes in the oil price. Volatility is likely to be higher, but you should expect commensurate returns.”
For more stable returns, Mr Webster recommends the SPDR Energy Select Sector ETF, which is dominated by oil majors such as Exxon Mobil and Chevron.
The other mainstream option is to invest directly in individual company stocks. Mr Webster says smaller oil companies such as Anardarko Petroleum, Apache and Hess offer potentially richer pickings than the global oil majors such as Exxon Mobil. “These tend to be more dynamic and a successful project can have a material impact on the share price. Just make sure you understand the risks.”
Investors should also consider the oil-services sector, the companies who provide equipment for drilling and production along with support services to the majors, Mr Webster says.
“The big energy companies spend about $500 billion a year on exploration and development, so investing in the companies receiving this cash can make sense. You could choose a dominant player like Halliburton, which has a strong hold in the US fracking market, or a niche player such as Hi-Crush Partners, which supplies the sand needed to keep cracks in shale apart once they been fracked.”
Platform support vessels , which support offshore oil rigs, are also attractive as offshore exploration expands, Mr Webster says. “Nordic American Offshore, for example, offers a modern and growing fleet and yields around 9 per cent.”
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