Niche Info Online Business

Philip Scott, This is Money

8 November 2007

A languishing dollar, rising tensions in the Middle East, and reports of diminished reserves in the US have sent the oil price soaring.

This week, West Texas Intermediate crude firmed to a record high of $98.62 a barrel. Already in 2007, prices have increased by a staggering 60% and many experts believe 'black gold' could be about to break the $100 barrier – and still have some distance to run.

The booming economies of China and India now account for 27% of world orders for oil and the International Energy Agency has cautioned that demand in these emerging markets will cause the oil price to rise even further.

Tim Guinness, manager of the Investec Global Energy fund says: 'The oil price is likely to have to rise to $150 a barrel before demand is significantly affected.' He believes there is still room for investors to participate. 'Oil and gas company shares are valued as if oil will be $55. If it averages say $85 there is big upside of 50% plus. If it goes to $150 there could be huge upside of 100% or more.'

Nik Bienkowski, head of research at ETF Securities, an exchange traded fund provider, adds: 'A lot of people laughed when $100 oil was mentioned two years ago, but now everyone from Mexican tortilla buyers to Italian pasta consumers realise cheap commodities may be a thing of the past. $100 a barrel oil is not so funny anymore.'

Robin Batchelor manager of BlackRock's MLIIF World Energy Fund says the oil market looks set to remain tight over the next 18 months. He adds: 'Many businesses are still valued assuming an oil price 30 or 40 dollars below today's level, so investors can benefit as valuations move up to bridge the gap.'

So how can you profit from a rising oil price?

FUNDS

You don't have to invest in a specialist oil portfolio to get exposure and gain from higher oil prices. Managers such as Bill Mott, responsible for PSigma Income, and Neil Woodford, who manages Invesco Perpetual Income, have more than 10% of their funds invested in the oil and gas sector.

Bradley Mitchell, manager of the Royal London UK Growth fund, has been predicting increased oil prices for almost two years and has been positioning his fund to take advantage of the hike. Mitchell has invested in specialist oil firms, such as Rockhopper Exploration, which is prospecting for offshore reserves around the Falkland Islands. Shares in the firm soared 10% a few days ago on good news about the firm's latest seismic surveys.

If you are looking for a more specific play there are general energy funds available. Mick Gilligan of Killik & Co cites Investec Global Energy, which invests in a combination of oil producers, refiners and services companies. His 'top ten' holdings include BP, Shell, Exxon and ConocoPhillips.

Gilligan also notes the ABN AMRO Energy fund, which is Luxembourg based but available to retail investors in the UK, as well as the Australian portfolio, Oceanic Natural Resources.

But if you want something a little more adventurous - and risky - you could invest in the Junior Oils Trust (JOT). Managed by Angelos Damaskos, the fund buys into small oil stocks, which the manager believes have the potential to grow rapidly. They may also be targets for a takeover by one of the multinational oil producers, who are discovering that buying up other companies is the easiest way to increase their own oil reserves.

Large players such as Shell, Exxon and BP are desperate for extra oil reserves as they simply do not have enough to meet demand, so they will be keeping an eye on the smaller players' fortunes.

One holding in the JOT is Burren Energy and the recent announcement of a takeover approach for the firm makes it the fifth core holding to be the subject of a bid during the past three years.

Mark Dampier of Hargreaves Lansdown, an independent financial adviser, says: 'Damaskos will only buy shares in companies that are cash generative and have proven oil reserves. He focuses the portfolios on his best ideas, holding a concentrated portfolio of just 23 stocks (of which the largest 10 holdings account for 50% of the fund) and keeping a little cash aside to take advantage of any new share issues that come to the market. Since launch the fund has grown by over 87%, which is well ahead of the oil price.'

EXCHANGE TRADED FUNDS

Exchange traded fund specialist ETF Securities has six oil exchange traded commodities (ETCs) that allow investors to gain direct exposure to one, two and three year oil futures prices in Brent and WTI (West Texas Intermediate) oil benchmarks. ETCs track the market in the same way as index funds, but like shares, you can buy and sell them during the trading day without having to pay stamp duty on purchases.

Currently most investors cannot invest in oil futures due to limited market access and lack of liquidity in pricing. Futures are financial instruments that allow investors to sell something they do not actually own in the hope of profiting from rising or falling markets.

Justin Urquhart Stewart of Seven Investment Management warns: 'As these ETCs are based on future pricing, investors will not be investing in a fund that exactly matches the present oil pricing and investing in a single commodity can be a risky strategy.'

SHARE TIPS

The market consensus is that Tullow Oil is a favoured stock – over the past 12 months it has risen 39%. The proposed takeover of Burren Energy has given its share price a boost over the past year it has increased by 39% and experts believe it has more to go yet.

Cairn Energy, up 30% over the past 12 months, has had some success with its oil fields in India and the market is hoping that this will continue.

Oil services firm Abbot, is up 13% over the past year while Hunting Group has risen 33%. John Wood corporation has shot up by 80%.

Bigger players such as BP and Shell have struggled in comparison, up 6.1% and 6.6% over the past 12 months. In the refinery business they have faced stiff competition and have endured problems on the processing side.