Has the price of black gold hit bottom already?

published 5 February 2015

If so, we're still in a different world from the one we knew, say John Stepek and Matthew Partridge.

Royal Dutch Shell is the best British company at using social media. And BP is best at using Facebook, according to digital corporate communications company Investis, says The Daily Telegraph. Anyone surprised by our oil majors' social networking prowess could be forgiven for thinking that they might be looking for alternatives to the oil business.

Oil prices have crashed since last summer. Various factors have driven the slide, including the rising US dollar, the end of quantitative easing (QE) in the US, and an epic battle for market share between oil cartel Opec, led by Saudi Arabia, and America's legions of frackers pumping out shale oil like there's no tomorrow.

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Of course, crashing prices meanproducers eventually end up cutting back. And few things sum up the general 'end of an era' atmosphere like the news that Shell is planning the "biggest North Sea decommissioning project to date", as the BBC puts it, removing "the first of the iconic Brent platforms", which date back to the 1970s.

While the Brent Delta platform no longer produces oil or gas, its planned demise is symbolic of the oil crash. That also makes it exactly the sort of thing a contrarian might expect to see at a market bottom. And right on cue, oil has rocketed in the past week. In fact, it's seen such a strong rebound that crazy as it may seem the price of Brent crude oil is now back in a bull market (it's risen by more than 20% from its lowest point, set in January, of just below $46 a barrel).

Oil price's big bounce

So why the rebound? And will it last? Speculators were heavily short the oil price, betting it would fall further. So any positive news which arrived last week in the form of a slide in the number of drilling rigs being used in the US, suggesting that some US shale producers were hitting their pain thresholds was likely to spark a rally. But there's more to it than that. The Paris-based International Energy Agency noted last month that "the sell-off is having an impact signs are mounting that the tide will turn", says the FT.

With companies cutting costs and cancelling new projects, supplies will eventually be crimped the energy watchdog cut its forecast for this year's non-Opec supply (from the US, but also Colombia and Russia, for example) by 350,000 barrels a day, to under a million.

Also, monetary policy is gradually loosening around the world again. One factor contributing to sliding oil prices was the end of US QE there was simply less money chasing assets around the world. So it's hard to believe that it's a complete coincidence that the oil price has bounced only shortly after the European Central Bank (ECB) announced QE. The ECB action has also sparked a round of currency-war-style reactions from central banks around the world, including the Australian central bank.

Back to 1986

So what could happen next? Predicting commodity price movements is no easier than trying to pick a top or bottom in any market. But history can provide useful comparisons. Oil has seen a few big bear markets like this one in the past, and an interesting research note from Indian financial services provider ICICI tries to pull out the most relevant example.

In this case, ICICI notes that the crash bearing the closest resemblance to the current slide happened between November 1985 and March 1986 which is striking, because BP CEO Bob Dudley also drew comparisons with 1986 when he was discussing BP's latest results this week. During that slump, the crude price plunged by nearly 70% (from around $27 to nearly $10 per barrel). This followed a 43-month period in which crude had traded in a range between $27 and $33.

The most recent slide followed a period of 39 months, in which oil traded between $80 and $115 (not quite as narrow a range, but not miles away). And so far it has corrected by about 60%. ICICI argues that $45 probably marked the bottom. The broker also reckons that, sticking with the 1980s scenario, the comeback could take some time maybe around two years to get back to the $80 level. Capital Economics agree that the rebound is likely to continue, with the price rallying to at least $60 this year.

So, if we've seen the bottom, what's the best way to play it? There are many small oil firms out there that may or may not make it. That's why private equity houses are salivating about raising money to invest in distressed assets. But this is a risky tack for a private investor to take. Even if the oil price has bottomed, oil at $50, $60 or even $70 a barrel is a far cry from the world that many explorers were expecting. We'd be more keen on the oil majors, and look at the most promising below.

The six oil investments to buy now

One way to profit from picking up distressed assets at bargain prices might in fact be to buy America's largest oil company. ExxonMobil (NYSE: XOM), reckons Bloomberg, "could be the big winner of the oil crash". The company missed the fracking boom in favour of concentrating on offshore drilling. But it is now in a prime position to benefit from the travails of small firms "now drowning in debt and low on cash".

As far as finances go, the company has $5bn in cash on its balance sheet. Profit-wise it made $6.5bn during the last quarter of 2014, down from $8.3bn the year before, but respectable given the oil-price slide. It pays a decent (for the US) dividend yield of just under 3% and trades on a price/earnings (p/e) ratio of around 12.

Everyone seems to think that BP (LSE: BP) which reported better-than-expected results this week is a takeover target. They may be right. Shell and Exxon have both been toutedas suitors and it's not beyond the realms of probability.

As Bloomberg notes, "the current crash in oil prices could usher in an era of mega-mergers similar to those in the late 1990s and early 2000s". But the main temptation is the dividend, which CEO Bob Dudley assured investors "remains the first priority". BP also offers a backdoor play on Russia one reason why this week's earnings were better than expected is because of its 20% stake in Russia's Rosneft. On balance, with that tasty yield of more than 6%, the potential rewards outweigh the risks.

Its FTSE 100 compatriate, Royal Dutch Shell (LSE: RDSA), is also well placed to benefit from any further rally in oil prices. Its operations are spread around the world, including Asia and the Americas, minimising the chances of problems in any one country or region having a major effect on profits. It also gets a lot of its revenue from liquefied natural gas. However, again its main attraction is its dividend payout of 5.8%. The company has also promised to return money to shareholders through buybacks. While the level of the dividend may be frozen if oil prices don't recover, Shell's balance sheet is strong enough to enable it to keep paying it for the next few years.

If you're looking for wider exposure to the sector, then the simplest way to bet on an upturn in the fortunes of energy companies would be to buy an exchange-traded fund that tracks the shares of energy companies. iShares Oil & Gas Exploration & Production UCITS ETF (LSE: SPOG) tracks the S&P Commodity Producers Oil & Gas Exploration & Production index. The focus is on large North American energy stocks, with American companies accounting for less than two-thirds of the portfolio and Canadian firms accounting for another 19%. It has an annual charge of 0.55%.

An alternative to the iShares tracker listed above is the Source STOXX Europe600 Optimised Oil & Gas UCITS ETF (Germany: SC0V), which includes globaloil majors, such as Royal Dutch Shell, Total and BP, giving the investor wide geographical exposure. It has a lower annual charge than its American counterpart of only 0.3%.

If you want an actively managed fund, you might want to consider BlackRock International Growth and Income trust (NYSE: BGY). The total expense ratio is 1.1% and it trades at a slight premium to its net asset value (partly as a result of the rebound in the oil price). While it invests in the usual giant oil firms, it also has exposure to theUS fracking firms, such as Devon Energy, and oil services firms such as Schlumberger. If the oil price continues to rebound, they could do extremely well. It also pays a prospective dividend yield of around 7%.

Stick with this play on British fracking

The US isn't the only one with lots of shale gas Britain has plenty too, writes David Stevenson. But getting it out of the ground isn't easy. Only 11 new shale gas and oil wells are set to be drilled this year, reports The Guardian. Now the government has accepted some Labour proposals to the Infrastructure Bill that could delay UK exploration even further. So what does this mean for the UK's largest "unconventional" gas explorer IGas Energy (LSE: IGAS), which we've tipped in the past?

The new rules aren't as bad for shale drillers as they sound. Explorers were set to implement most of them anyway. Despite pressure from a powerful parliamentary committee, at least UK fracking hasn't been banned for a second time.

But where does it leave IGas? UK onshore natural gas extraction is a high-risk business. And unfortunately, the shares have had a torrid time since June 2014. For starters, CEO Andrew Austin got involved in a wrangle over his shareholding. Whatever the facts, the price tanked. And of course, the crude oil crash has clobbered many smaller hydrocarbon producers.The net result has been an 85% plunge over the last year. Now there's talk that IGas may sell more shares to boost its coffers because its conventional oil revenues are being squeezed.

Yet it could be a mistake to sell now. Yes, there may be more bad news to come, but at the current price, the shares seem to be factoring in almost everything apart from IGas going bust. That has to be a longer-term risk, but already improving sentiment in the oil market has seen the stock rally. At this level, we're sticking with it.

David Stevenson edits The Fleet Street Letter.

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.