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Priming the pump

Gregor Watt looks at investment approaches to pick up on the possibly long-term high price of oil

The price of oil is high. At the time of writing, Brent Crude, the most common price for oil used in the UK, stood at $75.04 a barrel. This is down slightly from the all-time high of $78.78 earlier this month but is almost double the price of two years ago when it was at $40 a barrel and almost four times the price in 2002 when it was $20 a barrel.

There are many reasons why oil is at it current levels. Surging demand, coupled with problems in increasing world supply and difficulties in the countries of production have combined to push up prices .

The higher levels of demand are unlikely to go away. The rapid economic growth in China shows no sign of slowing down and other Asian economies are also showing strong demand.

As an example of the size of this demand, investment consultant Martin Barkwill says: “In the US car ownership is pretty much one to one. In China, it is nine to 1,000 but they have just embarked and a massive programme of road building and consumer demand and spending is growing.”

This demand is coupled with supply constraints for the oil producers.

Barkwill says “What we really need is a new strike of the size of the Saudi Arabian fields but the chances of this are pretty low.”

Alliance Trust global oil and natural resources analyst Angus McPhail says: “If current problems persist, we could be facing a period of higher for longer oil prices of above $60 for the next two or three years.”

Where are the best places to invest with oil prices staying high?

Barkwell says: “There is a very strong case to invest in a broad-based global energy fund.”

The choice here is limited, with just three separate funds, Investec global energy, Merrill Lynch international investment funds world energy and the junior oils trust.

All three funds have shown very strong returns in the last two years.

Even with the oil at a high level, Robin Batchelor and Poppy Allonby, co-managers of the Merrill Lynch world energy fund, believe there are further investment gains to be made.

Batchelor says the world energy fund has returned 170 per cent over the last three years and if oil stays high there are further gains to be made from oil equities.

He says: “Oil has gone from $20 up to $70 so a lot of the movement has already happened. The question is are investors going to decide that the high oil price will continue, in which case, oil equities have another leg yet to go.”

Batchelor thinks the high price is here to stay and with many oil companies yet to see the full effect of increase, there is better news for equity investors in this sector. He says: “I see further earnings upgrades for the oil companies and with lots of cash the possibility of share buybacks. I believe equities offer more potential than the oil price in the long term.”

Charles Stanley head of private client research Jeremy Batstone, agrees that oil equities are probably the best place to invest to take advantage of the high price of the underlying commodity.

Batstone believes most of the oil companies are quite attractively rated at present, with the best value being with companies involved in exploration. He says: “BP is not a bad place to start. Some other exploration companies, such as Cairn Energy, are also worth a look.”

Exxon Mobil and Statoil are also pegged as good prospects for growth.

Another way to invest in oil gains is in related industries such as engineering and service companies.

But McPhail says much of the value has already realised in such companies and they have little further growth to offer. He says: “There might be one or two instances, for producers of specific parts for oil production for example, but generally the oil service industry has been totally factored in to such an extent that there is little value left.”

Hargreaves Lansdown head of research Mark Dampier is sceptical about some of the forecasts for the oil business. He says: “The oil experts cannot even agree when we will reach peak production for oil or if we are already past it.

“Oil is still a commodity and no one has ever really managed to successfully predict the prices of commodities.”

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