Opportunity Knocks: Has the oil price bottomed?

Opportunity Knocks: Has the oil price bottomed?
Few areas have escaped the stock market down turn – some have performed worst than others. The price of oil has fallen from a peak of $147 to around the $40 mark which could be throwing up a buying opportunity.

By Paul Farrow
Last Updated: 9:44AM GMT 13 Feb 2009

The oil price has fallen from a peak of $147 to around $44 a barrel Photo: BLOOMBERG NEWS
The financial crisis has left many assets and sectors battered and bruised. The stock market is down by more than 30pc over the past year. The global economy is on its knees but history suggests that equity markets will begin their recovery before GDP figures start to show strength again.

Investors who will gain the most will be those with either the nous or the brass neck to get in early. There are some fund managers that reckon that the fall in the oil price could open such an opportunity. The question is whether those investing in the sector now are jumping the gun?

Oil reached a peak of just under $150 a barrel last year – today it stands at jaround $40. The demand that pushed the price to record highs has slumped as many global economies have slowed. Some analysts are reticent to suggest how long the global recession will last, but when the stimulus injected by central banks begins to filter through the demand for oil will pick up.

Several already believe that investors should start to look at oil – they do not say the price has bottomed or a spike in the price is imminent, but they reckon that a floor cannot be too far away.

Demand for oil has collapsed because of the very weak economic conditions, and the price of oil has fallen as a result. Production is also falling – non-OPEC production peaked last year and is now on the decline.

This week, crude fell after the US Energy Information Administration revised down its 2009 global oil demand forecast by 400,000 barrels per day from its previous outlook, predicting demand will fall by 1.17 million bpd this year from 2008 levels. US crude stands at around $34 a barrel. London Brent stands at $45 a barrel.

But Killik, the stockbrokers sent a note to investors reckoning the "momentum is negative and crude is approaching oversold levels – short-term traders should go long at current levels with a tight stop loss'.

Mick Gilligan, an analyst at Killik says the price of oil is wrong in the medium term and says that his clients are buying exchange traded funds to benefit from the low price – particularly US oil which is lower than the price of Brent crude.

Chris Wheaton, Director, RCM, the specialist equity company of Allianz Global Investors, says: "Oil has been included in the January sales. Even if oil is only $50/barrel in 2010 it makes for a great investment opportunity right now. Low prices are encouraging more energy use – for example, gasoline demand in the US is now at the same level it was last year despite all the talk of a weak US economy. Sometime in 2009 or early 2010 we expect oil demand across the world to start to grow again.

"The credit crunch and uncertainty over oil prices are causing investment in new oil fields to be put on hold. However the big trends, such as rising energy use across emerging markets and natural declines in existing oil production won't disappear and will continue to push oil prices higher. This means were certainly going to have $100/barrel oil again by 2013, and makes longer-term investments in energy at today's prices look very attractive."

Robin Batchelor manager of the Blackrock World Energy fund says that both oil and gas prices are trading below their marginal costs, which are unsustainable for any reasonable time frame – but he admits that economic woes do raise concerns on the demand side of the equation.

He says:"However, energy equities are trading at P/E multiples at a discount to the broader market and are generally supported by asset valuations. Almost all the companies in the portfolio are well-capitalised and generating cash. At some point in the relatively near future, we believe fundamental factors will regain their importance as investors again return to traditional valuation techniques."

Gary Dugan, Chief Investment Officer, EMEA, Merrill Lynch GWM, reckons that for those who want to trade oil, we are very close to buying levels – anything below $35 is a buying opportunity.

He says: "When the oil price starts to move towards $30 a barrel it starts to cost more to extract oil than producers can get by selling it, so production facilities get shut down as they become uncommercial. We expect the annual production of oil to fall by as much as 5pc a year over the next five years, which should create a floor for the oil price. We believe that oil will bottom out at around $30, and will average between $40 and $45 over the course of 2009, subsequently rising to around $55-60."

But before investors rush to get a piece of the action, there are some who are not so sure now is the time.

Ian Henderson, who manages the JPMorgan Natural Resources Fund, is not convinced that now is the ideal time to invest in oil related plays – mainly due to the uncertainty of the US, which he says will dictate sentiment. He continues to bet on gold which makes up the lionshare of his portfolio at this juncture.

"The long-term view remains in tact but there is so much global uncertainty. But there are dozens of cargo ships floating around refineries because demand for oil is weak -there is plenty of oil floating around – it could be that we will have to wait until that is through the system before the price rises," he says. "However, many oil companies have strong balance sheets having been buoyed by the high price in the past which makes some oil stocks a useful hold for those looking for dividends – although so too do the likes of Vodafone and Glaxo."

For investors wanting to take advantage of any future rises in the price of oil, there are a number of choices. You could invest directly in the shares of the oil majors and production and service companies. Other options include investing in funds that look at the oil sector (Guinness Global Energy, JPM Natural Resources, Investec Energy), or in an exchange-traded fund, which is an investment vehicle that holds assets such as stocks or bonds.

Oil shares do not move directly in line with the oil price because there are other factors at work such as management skill, debt and the costs of distribution. However, there is a correlation over the longer term and they are paying decent dividends.

Remember that oil stocks in the UK make up a significant chunk of the FTSE100 so any tracker fund or General UK Growth fund that does not veer too much away from the index will benefit from any pick up in demand for oil – and those bumper dividend payments.

http://www.telegraph.co.uk/finance/personalfinance/investing/4609834/Opportunity-Knocks-Has-the-oil-price-bottomed.html