Profits down at Shell – Should investors tap into oil?

2nd February 2012

Factors affecting the oil price

An EU embargo on Iranian oil imports will likely be delayed for 6 months so that countries including Greece, Italy and Spain can find alternative supplies. After all, the embargo would force European refiners, which imported about 0.5 m barrels a day of Iranian oil last year, to look for other suppliers – but replacing Iranian oil will be a difficult task.

To add to this, there are tensions over Iran's nuclear ambitions, rising militant activity in Nigeria and worries over suicide bomb attacks in Saudi Arabia. The US has imposed sanctions against Iran's central bank and it is highly likely that Japan and South Korea will reduce their imports of Iranian oil.

Given these factors, there is an argument for speculators to push oil prices higher. However, investors should be prepared for volatility if they choose to dip a toe into the energy market.

Take 2008 as an example. After crashing through the $100 barrier at the start of the year, by July the price of crude oil had soared to a high of $144.95 per barrel only to subsequently slump back down to a 12-month low, falling in value by 74%.

While the first few weeks of 2012 were less volatile, with crude oil prices trading both sides of $100 per barrel, who knows what's ahead? Turning back to 2011, this was a relatively stable year for oil prices. Brent crude oil traded in a narrow band all year between $100 and $120 a barrel. But 2012 may be a very different year with traders bracing themselves for a much rougher ride, stresses Wall Street Mess.

Investing in oil

Oil is fundamentally linked to the economies of both the developed and emerging markets of the world and can be an indicator for economic health and a driver of it. The 1973 Yom Kippur War and the 1979 Iranian revolution both led to jumps in the oil price that presaged economic downturns, for example.

Oil is often dubbed 'black gold'. Like many other commodities, such as gold, platinum and corn, it has traditionally a low correlation with equities – therefore oil and oil related investments in a portfolio can provide a healthy element of diversification, as well as a hedge against inflation. But if you believe the price will be pushed higher, and can hold your nerve, there are several ways to take a punt on this.

Individual shares

As a general rule, commodity stocks are highly volatile so spreading your investments is recommended.  However, the most obvious method to tap into oil is to invest in a company within the oil industry, such as BG Group (BG), British Petroleum (BP), or Tullow Oil (TLW).  

Some experts claim that BP may see strong share price appreciation as a result of any settlements prior to the start of Federal Court proceedings next month, while exposure to Brazil, among other factors, positives for BG Group.

Exchange-traded funds

Another route to consider would be using an ETF, or Exchange Traded Commodity (ETC) that tracks the oil price. Exchange traded funds mirror the performance of a particular index or market. Investors can trade them during the day in the same way as ordinary shares but they are free from stamp duty charges, and therefore a popular investment.

Funds

Most UK funds will have exposure to oil. Considering commodities and resources firms now make up around a third of the FTSE index of the UK's top firms, this is unsurprising.

The outlook is uncertain – as it is for the economy as a whole. Both bulls and bears could be right depending  on what events comes to pass. Either way, 2012 looks to be a far more interesting year for the oil market than 2011 was, and for the brave investor, it could prove profitable.

 

More from Mindful Money:

Commodities: Is the super-cycle coming to an end?

Are global corporations a safer bet than governments?

Water: Threat, Stress and opportunity

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