THE IMPORTANCE of oil to investors has been underlined as President Trump’s tough line on Iran stoked a further rise in the price of crude.
Despite widespread predictions a year ago that oil would struggle to top $50 a barrel under pressure from US shale production, it topped $77 this week.
Big oil is a pillar of the FTSE 100 and of popular investment funds, and its strength helped the blue-chip index jump nearly seven per cent last month, bouncing back above 7,500 from its February depression.
So should investors be checking their exposure to the black gold, and do the latest geopolitical rumblings in the Middle East signal another bout of volatility ahead?
“Investors do need to keep an eye on the price of oil, which is now up 50 per cent year-on-year,” said Russ Mould, investment director at AJ Bell.
“A sustained surge in crude could lead to inflation or even a slowdown in global economic activity. The higher oil goes, the more dangerous the impact of the Trump policy shift could become.”
Read more: Oil price hits three year high as tensions over Syria increase
Richard Turnill, Blackrock’s global strategist, added: “For investors seeking exposure to oil today, we see a stronger case for investing in energy equities over crude itself. Oil prices have run well ahead of energy stocks this year but this trend has started to turn.”
Surprisingly, the index of FTSE All-Share oil and gas producers is up only 4.4% in 2018, ranking it 13 out of 39 industry groupings, while the oil equipment and services sector is up by just 0.9%.
The producers’ index currently trades at 128 times the actual oil price, compared to an average of 156 over the last 20 years.
Mr Turnill said: “Current oil prices offer potential upside for energy companies’ earnings and stock prices.
"Most energy companies have budgeted for mid-$50s oil prices in 2018, with this conservative outlook reflected in share prices today.
"This points to valuation upside should current levels of oil prices be sustained.”
BP and RoyalDutchShell are strengthening the cover of their dividends as the oil cash flows in and both still offer yields of over five per cent. Mr Mould said that “less-well developed, pure play producers” such as Edinburgh-based FTSE 250 firm Cairn Energy or London-headquartered Tullow Oil could also benefit, although with a higher level of operational and exploration risk.
“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,” he said.
“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.”
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There are actively managed funds focused on the sector such as Guinness Global Energy, which has almost two-thirds of its assets in North America, while passive funds include ETFS US Energy Infrastructure and iShares US Oil & Gas Exploration & Production, both exchange-traded funds.
The iShares Core FTSE 100, meanwhile, has both BP and Shell in its top five holdings and an overall weighting of 17% to energy. Among UK equity income funds – the top-performing fund sector last month - River & Mercantile UK Equity Income has a 15% energy exposure.
For those who are happy to swap equity risk for oil price risk, ETFS WTI Crude Oil (CRUD) tracks the US benchmark, West Texas Intermediate, while ETFS Brent Crude (BRNT) mirrors European oil. Both of these funds use derivatives to track the prices, which can affect returns.
Turnill cautions that there could still be “a hefty drop in oil prices, possibly sparked by a large US shale production boost or falling demand”.
Oil futures, which predict the price ahead, have lagged the rise in spot prices, while a stronger dollar could also weigh on oil.
Tom Elliott, international investment strategist at deVere Group, said: “Investors should expect an increase in market volatility. In the shorter term at least it is likely gold and the US dollar may rally on growing fears of further conflicts in the Middle East breaking out, while risk assets, namely stocks and credit markets, may weaken. Oil may rally strongly.
“Geopolitical events such as these underscore how essential it is for investors to always ensure that they are properly diversified - this includes across asset classes, sectors and geographical regions – to mitigate potential risks to their investment returns.”
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