How to play an oil price rally

oil-barrels-lying-on-us-dollar-notes

Oil prices began to tick up on Wednesday evening after the Organisation of the Petroleum Exporting Countries (Opec) announced it had agreed a deal to cut crude oil output.

The price of both WTI and Brent Crude oil, as well as the share prices of oil firms including Shell and BP, all finished Thursday up between 4.5 and 7 per cent on Tuesday's close.

The boon for the sector came as Opec announced it would cut output to 32.5 million barrels of oil per day (bopd), from a current 33.24 million bopd. The deal will be put to the oil cartel's next formal meeting in November in Vienna.

What might higher oil prices mean for investors?

CAUTION URGED

With the cuts only agreed in principle at the moment, the announcement didn't quite spark a sustained rally, and oil prices retreated slightly on Thursday and Friday, although were still well up on earlier in the week.

Jason Hollands, managing director of communication at Tilney Bestinvest, says there are good reasons to be cautious as there is every chance the deal could unwind because cartels are notoriously unstable.

'It may well, therefore, transpire that this move helps stabilise prices at around the $50 range,' he tells Money Observer, 'but I think it is too early to get overly bullish and start assuming that price is about to head past the $100 a barrel levels seen a couple of years ago.'

But some investors may be more confident the deal will stick and push oil prices even higher, so we spoke to three experts to find out the best ways to boost your exposure to the commodity.

ETFS

The starting point, especially if you believe the oil price will continue to edge up, would be an exchange traded fund (ETF).

Indeed, points out Hollands, many who own a UK index tracker are likely to have exposure to the likes of BP and Shell already, considering the oil and gas sector represents over 11 per cent of the blue-chip index.

Therefore, 'investors should think twice about whether they really need to take a punt on a specialist oil fund'.

'For those who are determined to make such a trade then there are a wide selection of exchange traded products that track crude oil futures prices (ETFS WTI Oil USD) as well as oil stocks (DB X-Trackers STOXX Europe 600 Oil & Gas UCITS ETF),' he says.

An alternative, according to Russ Mould, investment director at AJ Bell, is the ETFS US Energy Infrastructure ETF, which follows a basket of 24 American energy pipeline, storage and logistics firms and offers a dividend yield of above 6 per cent.

How to invest using ETFs

FUNDS

As mentioned, anyone who owns a generic UK index tracker will already benefit from oil stock price rises; for those who do not, Mould suggests the BlackRock 100 UK Equity tracker, which comes with an ongoing charges figure of just 0.06 per cent.

This fund counts Shell and BP in its top five holdings, as do a number of actively managed funds. One of these, Mould says, is the Schroder UK Alpha Income fund, run by Matt Hudson.

For those looking to take a high degree of risk, Hollands points to MFM Junior Oils Trust. Managed by Angelos Damaskos, this fund invests in smaller and medium-sized businesses.

SHARES

Another riskier punt would be going directly through shares, with BP and Royal Dutch Shell the biggest listed on the London Stock Exchange. The former began Friday at 447p, up 3.7 per cent from Wednesday's close; the latter at 2,000p, 5.5 per cent up.

Both firms currently pay dividends of over 7 per cent, although the sustainability of those yields have been called into question due to low dividend cover of around 0.5 times.

Colin Morton, vice president and lead manager of the Franklin UK Equity Income fund, says a continued rise in the oil price will instil confidence that these companies will be able to pay their current levels of dividend, which are 'attractive' in a low interest rate environment.

Six funds for a low interest rate environment

'However, investors should continue to diversify their portfolio as the backdrop of slow economic growth, the risk of quotas not being met and the potential for US production to increase all means that these yields are unlikely to be sustainable in the long term.'

Shell is currently the top holding in Morton's fund, with BP just outside the top five holdings.

For those wanting to look a little further down the market-cap spectrum, the FTSE 250 offers exposure to less well-developed, pure play producers such as Cairn Energy and Tullow Oil. Mould says these firms could also benefit, 'but the operational and exploration risks are higher'.

He continues: 'The riskiest oil plays are the Aim-quoted junior explorers which may not even be producing or have a find, but whose share prices could welcome more positive sentiment toward their industry.'

BONDS

'Fixed-income investors will doubtless be watching the bonds issued on the London Stock Exchange's Order Book for Retail Bonds with interest,' says Mould.

Two oil companies, Enquest (EnQuest 5.5% 2022 bond) and Premier Oil (2020 Premier Oil bond), offer retail bonds through this platform paying coupons of 21.2 and 11.8 per cent respectively.

'Both trade well below par, owing to fears about how a long run of low oil prices could leave their balance sheets looking very stretched,' Mould explains.

'If oil makes great gains and holds on to them this could ease the pressure on both firms, boosting the price of their shares and their bonds - but the very high coupons involved make it clear that the risks are very high and neither is suitable for widows or orphans.'


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