Navigating a low oil price

Each week, a professional investor tells us where he’d put his money. This week: Simon Gergel of the Merchants Trust.

Navigating these uncertain political times is a tricky matter for fund managers these days. Brexit is, of course, a risk to the economy. However, many UK companies are exposed to relatively stronger global markets, where data is positive. As a result, the UK market remains steady, with volatility low. One sector particularly exposed to volatility over the last decade has been the oil and gas producers. Between 2011 and 2014, the price of Brent crude was above $100 a barrel. By early 2016, it had slumped to $27 a barrel, with fears that things could only get worse when Western sanctions on Iran were lifted, exacerbating the oversupply problem.

Today, producers that are members of the oil cartel Opec and Russia have helped to drive Brent back above $60 per barrel, by holding back 1.8 million barrels a day in oil production to tighten markets and prop up prices. Supply cuts are likely to extend beyond March 2018.

The oil and gas producers have posted strong returns as a result – they rose by an estimated 6% in October alone, responding to the oil price breaking through $60, its highest level since mid-2015. There were also encouraging results from the big oil companies, showing they are now generating enough cash to cover dividends after capital expenditure costs. This is an important milestone for major oil companies – it suggests they’ve successfully restructured their models to be more resilient in a low-price environment, and are now generating sustainable dividend yields. Roughly 14% of our portfolio at the Merchants Trust is in the oil and gas sector. The following three stocks were among the best contributors to the positive performance of our portfolio in the third quarter of 2017.

British oil giant BP (LSE: BP) saw profits jump in the third quarter thanks to higher production and strong downstream earnings – pre-tax profits more than doubled in the period to $2.95bn, up from $1.33bn a year ago. The company attributed the successful quarter to three new upstream projects and its highest downstream earnings in five years, and it has exercised spending discipline to generate healthy earnings and cash flow.

Royal Dutch Shell (LSE: RDSB) profits hit $3.7bn in the third quarter, which has enabled the group to resume paying its entire dividend in cash. Profits were helped by a strong performance from its refining business. Shell’s gearing (level of borrowing) stands at 25.4%, but the leadership team is committed to reducing borrowings over the near-to-medium term, and reducing the share count via buy-backs in the longer term.

Outside the oil sector, outsourcer Equiniti (LSE: EQN) has also been a strong performer this year, driven mainly by two events. Firstly, rival Capita sold its registrar businesses at a price that implies Equiniti is significantly undervalued. Secondly, Equiniti bought Wells Fargo’s US registry business, providing significant potential for near-term cost savings and longer-term growth opportunities.