This article is part of Morningstar.co.uk's Equity Investing Week.
Global demand for energy has risen inexorably over the past 150 years and this trend is set to continue, with surging demand from developing countries such as China and India. Increasing demand coupled with supply constraints should lead to further price increases, creating opportunities for investors in the energy sector.
As Western economies look at renewables, and elsewhere nuclear and petrochemicals are the focus, there is a plethora of options to explore for investors.
Energy-Focused Funds
Naturally, given the risks inherent in investing in individual stocks, the safest way to gain exposure may well be to invest in funds that have a diversified holding across many different stocks, sectors and geographies.
It is also important than investors be prepared to hold these investments for a minimum of 3-5 years. Investing for the long-term has been proven to be the best strategy.
Based purely on the criteria of annualised performance over ten, five and three years the following funds are worth considering within the Morningstar's Energy Equity sector:
• The Odin Offshore fund (Rating: Neutral) has the best performance among energy sector funds over 10 years according to Morningstar data, delivering a 10-year annualised return of more than 20%. It is an index-independent global fund and can only invest in companies that are mainly involved in the oil and gas sector.
• Over five years one of the top performers has been the Investec GSF Global Energy fund (Rating: Under Review). This fund has produced an annualised return of 2.89% in sterling terms. It aims to achieve capital growth by primarily investing in companies throughout the world involved in the exploration, production or distribution of oil, gas and other energy sources.
• Over three years the top performer in this sector is the MFS Meridian Global Energy fund. It has produced an annualised return of more than 6% over those three years. The fund invests in companies in the energy sector located in developed and emerging market countries.
Energetic Equities
For those willing to take on more risk by investing directly in shares, it may pay to look at some large players in this area.
Two possible stocks to consider, with varying degrees of risk are:
Cairn Energy (CNE)
Cairn has an enviable track record of producing great returns for shareholders and is now in the process of re-organising its portfolio. Its intention is to use cash from producing assets in the UK and Norwegian North Seas to finance possibly transformational exploration in Morroco, Greenland and Spain, with license bids pending in Lebanon. It appears undervalued, since its market capitalisation is around £1.7 billion, which means it's trading at the same value as its cash pile and its 10% stake in Cairn India. Of course, this discount is due to the fact that it is involved in high-risk, expensive exploration. But even so, any positive news could send these shares much higher.
Royal Dutch Shell (RDSB)
This oil and gas major is in a good position to exploit the expansion of the Asia-Pacific energy market. Moreover, it throws off cash and trades on a forward price-earning ratio of only nine. Given the demand for energy, this company is likely to keep on producing huge profits for the forseeable future, despite a constant demand for significant capital expenditure.
There are plenty of other opportunities available. For example, according to Morningstar analysts, some of the most undervalued oil & gas companies right now include BG Group (BG.), Technip (TEC), Noble Corporation (NE) and Transocean (RIG). All these companies currently have four-star ratings from Morningstar.
