The oil price has reached a three-and-a-half year high and commentators say political tensions could drive it higher still – that means there could be opportunities for brave investors.
Oil this week reached $78 a barrel for the first time since 2014. A fall in supply and geopolitical uncertainties have helped drive the price upwards; US President Donald Trump has pulled out of a deal between Iran and the United Nations Security Council in a move some fear could lead to strict sanctions on imports of oil from the country.
If this happens, then supply of the black stuff could fall by as much as half a million barrels a day, increasing demand and driving the price higher. As a result, Jordan Hiscott, chief trader at ayondo markets, thinks the oil price could reach $100 a barrel over the next year.
He says: “This is on the basis of the unpredictable nature of disruption from key suppliers and the seriousness of what could arguably be a proxy war in the Middle East in the form of Syria from both the US and Russia backing its respective allies and interests.”
Richard Robinson, manager of the Ashburton Global Energy fund, adds: “The implications for the market fundamentals are bullish – the market can hardly afford yet more oil to be removed from an already tight and tightening outlook.”
He says the rate of decline in oil inventories over the past year has been “unprecedented”. A sharp drop in spending by oil firms between 2014 and 2017 has come as the same time the International Energy Agency reports says global oil demand has climbed to 99.3 barrels a day; it suggests the market could enter a deficit this year as demand may soon outstrip supply.
$75 a Barrel is the Key Level
Christopher Korpan, co-manager of the JPM Natural Resources fund, says: “The recent surge in the oil price was unthinkable only a year ago, when optimistic forecasts predicted a price of $50 a barrel.”
Oil peaked in 2008 at an eye-watering $147 a barrel but many investors suffered huge losses when a glut of supply, along with a global financial crisis, saw the price of crude plunge to just $27.
Oil producing nations ramped up production to stave of competition from the shale gas industry, with little regard for the catastrophic effect it would have on profitability. Commodities companies need the oil price at around $75 a barrel to maintain profitability and, finally, these levels are starting to be achieved again.
The outlook started to look more positive in 2016 when oil cartel Opec agreed to cut production by 1.2 million barrels a day in a bid to shore up the price of the black stuff.
A shift away from fossil fuels to shale gas for energy and to electric cars, for example, means there are clouds on the horizon but many of the oil majors are diversifying into renewable energy, so should be able to tap into this trend while retaining access to their roots in fossil fuels.
Earlier this month, Morningstar analysts upgraded their rating on oil giant BP after strong first quarter results pushed shares to an eight-year high. Underlying profits at the business grew to $2.6 billion from $1.5 billion and analysts expect production to grow at 4% a year for the next five years.
Commentators are also positive on FTSE 100 oil producer Shell, which analysts say is undervalued.
FTSE Has Heavy Oil Weighting
One option for investors looking for exposure to the energy sector is JPMorgan Natural Resources. The fund, which has a Morningstar Bronze Rating, has an overweight position in oil and gas exploration with top holdings including French firm Total and UK-based businesses Royal Dutch Shell (RDSB) and BP (BP). It has returned 23.1% over the past year, but over the past decade has produced an annualised return of -2.8%.
Morningstar analyst Fatima Khizou says the fund “is a solid proposition for investors who understand its risks and distinct features”, with investments in small cap companies and those still in the pre-production and discovery stages of the process.
But investors don’t have to pick a dedicated resources fund to get exposure to the sector. The FTSE has a notoriously large exposure to the energy industry, meaning UK equity funds can provide exposure to the big oil names while also bringing the diversification of other holdings.
The largest three holdings in Morningstar Silver-Rated Invesco Perpetual UK Growth, for example, are Total, BP and Royal Dutch Shell. But the fund also invests in insurance group Legal & General and telecoms firm Vodafone. The fund is up 9% over the past year and has produced a 10-year annualised returned of 8.3%. Morningstar analyst Peter Brunt says energy is one of the largest sector overweights in the fund and a “bullish view on markets has led to an increase in cyclical stocks”.
Korpan adds: “Even without the geopolitical factors, there are fundamental reasons that support the recent rise in the oil price – strong global demand and underinvestment by exploration companies – and suggest it will keep rising.”
