Features

Should you top up on oil?

Oil’s middling price range is holding, and a slump looks unlikely. Max King picks a good way to buy in to oil

The recent drop in the oil price to just above $50 a barrel has given new heart to the bears, who point out that the oil cartel Opec's attempt to curtail production was always doomed to failure, given that its members control just a third of global output. Meanwhile, James Anderson, co-manager of the Scottish Mortgage Investment Trust, warns that "the age of fossil fuels is over", thanks to the growth of alternative energy and electric vehicles.

Perhaps that's true. But for now at least, demand for oil is running at 96 million barrels per day (mbpd) and continues to grow by about 1mbpd each year. And new discoveries or extensions of existing oil fields are needed every year to satisfy demand, as older ones are depleted. Yet the big oil companies have had their fingers burnt on major projects. For example, Shell spent $7bn on drilling in Arctic waters before it stopped in 2015.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

As Anatole Kaletsky of Gavekal says, the majors have now abandoned their obsession with reserve replacement, once considered a symbol of success in the industry, and are focusing on profit and cash flow. Contrary to the assumption of many investors, these are not just a function of the oil price.

A high oil price encourages host countries to raise taxes or grab ownership of the reserves, whereas a low one makes them more accommodating. So a middling price of $50-$60 suits the industry well. It keeps governments at bay and discourages excess investment, yet provides a good return on existing fields. The good news for oil investors is that this "middling" price range still holds and a slump to the $30-a-barrel level of late 2015 looks unlikely.

Advertisement
Advertisement - Article continues below

If you own any global or regional equity funds you will have significant exposure to the energy sector, mainly through international integrated companies (the oil majors such as Shell or Exxon). Only committed oil bulls will want to add to that through a general sector fund. However, specialist funds focusing on smaller companies or private equity are another matter.

In late 2013, with shrewd timing, Riverstone Holdings launched its Riverstone Energy (LSE: RSE) investment trust, raising £760m to invest in private-equity energy projects in North America. The trust didn't start to deploy this capital seriously until a year later, when oil prices had tanked and assets were much cheaper. Today, 84% of the trust's total assets of $1,700m are invested in 16 active investments, of which 15 are in North America. US oil production has doubled in the past decade and gas production is up 50%, thanks to fracking technology driving down energy prices.

For Riverstone, this is an opportunity. Managing director Alfredo Marti remains optimistic. Under Donald Trump the US government "is cutting red tape, environmental restrictions and tax," he says. "Yet even under [Barack] Obama, production of oil nearly doubled." However, he says, it's mainly technology and innovation, not politics, that are driving the sector. Production costs continue to fall. In parts of the Permian Basin, where Riverstone has significant exposure to shale oil, "triple-digit rates of return are sustainable". Riverstone is also bullish on western Canada, the Bakken and the Eagle Ford fields. Marti sees longer-term potential in Mexico, Argentina and oil services. Yet despite this upbeat outlook, the shares trade at a 19% discount to JP Morgan Cazenove's estimate of the trust's current asset value. You don't have to have a view positive or negative on the oil price to invest.

In the news this week

A total of 87% of UK active equity funds failed to beat the benchmark over the past year, according to the latest S&P Indices Versus Active Funds scorecard. This is a near-fourfold increase on 2015, when 22.2% of funds underperformed. The average UK active equity fund performance also lagged the benchmark over one year, with active funds delivering an average annual return of 11.2%, which is almost 6 percentage points lower than the S&P UK benchmark index over the same period. These findings will "strengthen the hand" of the Financial Conduct Authority, which has proposed a shake-up of the UK fund-management industry, says Chris Flood in the Financial Times. The FCA concluded last year that actively managed investments did not outperform benchmarks once costs were taken into account.

Fidelity International has become the latest investment manager to move into the growing exchange-traded fund market, launching two income-focused ETFs this week, says Flood. The Fidelity US Quality Income ETF and the Global Quality Income ETF will carry an annual fund charge of 0.3% and 0.4% respectively. Both will track proprietary Fidelity-branded indices, rather than the benchmarks run by established providers S&P Dow Jones Indices or MSCI. Fidelity plans to launch more smart-beta (the term used for index-linked strategies which pick investments based on factors other than market capitalisation) ETFs over the next 18 months as demand for investment strategies grows. Globally, 230 smart-beta ETFs were launched last year.

Activist watch

The activist investor Sarissa Capital Management is pushing for a sharp cut in the compensation of Innoviva's chief executive, in the latest stage of the fund's battle with the US-listed drug company, reports Reuters. Sarissa, which has nominated three directors to Innoviva's board, has criticised the company's cost structure and claimed that levels of executive compensation are too high "considering that it only manages drug royalties and does not market or sell any products". In a letter sent to shareholders last week, Innoviva said that its strategy was working and that Sarissa had launched an "unnecessary and distracting" proxy fight to replace a near majority of directors. The fund holds a 2.7% stake in Innoviva.

Advertisement

Recommended

Visit/520272/iran-and-us-oil-price
Global Economy

What escalating tension between Iran and the US means for oil prices

The tension between the US and Iran is unlikely to mean all-out war in the Middle East. But markets may be getting a little too complacent about its e…
6 Jan 2020
Visit/519785/rising-output-will-keep-a-lid-on-the-oil-price
Oil

Rising output will keep a lid on the oil price

Oil exporters’ cartel Opec gave further encouragement to the bulls this month after agreeing to new production curbs.
20 Dec 2019
Visit/518797/brace-yourself-for-pricier-oil
Oil

Brace yourself for pricier oil

Global growth, and hence demand for oil, could surprise on the upside next year, leading to a bounce in the oil price.
29 Nov 2019
Visit/515540/why-has-the-oil-market-taken-the-saudi-attack-so-calmly
Economy

Why has the oil market taken the Saudi attack so calmly?

After an initial spike in the oil price, the market seems to have shrugged off the attack on Saudi Arabia’s oil infrastructure. John Stepek asks if it…
23 Sep 2019

Most Popular

Visit/economy/600632/money-minute-friday-17-january-uk-weakness-likely-to-continue
Economy

Money Minute Friday 17 January: UK weakness likely to continue

Today's Money Minute previews UK retail sales figures the UK, inflation data from Europe and industrial production from the US.
17 Jan 2020
Visit/520525/currency-corner-how-high-can-the-pound-go-against-the-euro-in-2020
Currencies

Currency Corner: how high can the pound go against the euro in 2020?

In the month in which we should finally leave the European Union, Dominic Frisby takes a look at the pound vs the euro and asks just how high sterling…
13 Jan 2020
Visit/investments/property/house-prices/600638/uk-house-prices-may-be-heading-for-a-boris-bounce
House prices

UK house prices may be heading for a Boris bounce

The latest survey of estate agents and surveyors from the Royal Institution of Chartered Surveyors is "unambiguously positive" – suggesting house pric…
16 Jan 2020
Visit/investments/stocks-and-shares/share-tips/600636/class-acts-going-cheap-buy-into-europes-best
Share tips

Class acts going cheap: buy into Europe’s best bargains

Value investing appears to be making a comeback, while shares on this side of the Atlantic are more appealing on metrics such as price/earnings ratios…
16 Jan 2020