Oil prices are set to remain low for the medium term following their most recent falls and longer term plunge, according to chief investment officer at Kames Capital’s Stephen Jones.
The nose dive in the oil price was one of the biggest financial and investment stories in the second half of 2014 with a low oil price widely touted to end in 2015. Since the middle of last year, oil has plummeted and while most of this year has seen a period of stabilisation, the past six weeks have seen it continually head further south, fast.
According to FE Analytics, Brent crude has lost 58.02 per cent of its value between June 2014 and Friday that do not yet capture the further falls today.
Performance of index since June 2014
Source: FE Analytics
Brent crude futures prices fell to fresh multi-month lows early today. Brent fell to $48.35 per barrel, not far from a six-year low of $45.19 hit in January, according to analysts at ETX Securities.
Jones believes ongoing pressure from the dollar, an increasing pipeline of supply, and a lack of global demand will keep it pegged back.
“Oil in triple digits will be a distant memory,” he said. “Although the commodity bounced off previous lows, that was to be expected given it had halved in value over the course of the last year, and the simple fact is the asset class remains challenged.
“Despite bottoming earlier this year and staging some form of recovery, the fundamentals remain the same for oil. The rig count in the US is now rising again, new pipelines of supply are set to come on stream, and there is a lack of growth globally which is keeping demand subdued.”
One of the knock-on effects of the yearlong trend has been a heightened worry that lower oil prices could put the dividends of UK equity income funds at risk due to the high proportion of funds and trusts in this space that hold energy-related stocks.
The likes of BP and Royal Dutch Shell are among the most popular to be held in the UK equity income space due to their perception – and track history - for regularity and stability in paying consistent and growing dividends, a feature that many investors, both directly and indirectly, rely upon.
For example just before the oil price fall FE Trustnet revealed that more than 90 per cent of UK equity income funds had one of the stocks as a top holding.
Earlier in the year, for example, Franklin’s Colin Morton said that BP and Shell’s dividend’s weren’t at risk unless there was another major fall in the oil price – an event which has since happened.
“The problem will be if the oil price stays low for any length of time, as these companies will be paying the dividend out of the balance sheet,” Morton said.
“At the moment, I’m willing to give them the benefit of the doubt that these dividends are absolutely safe, certainly for 2015 and probably 2016, unless there is another massive collapse in the oil price.”
Since oil starting falling last year the FTSE All Share has grinded higher with a 4.81 per cent gain however BP and Shell have seen their share prices fall significantly. The former is down 21.56 per cent and the latter is down 18.11 per cent.
Performance of stocks and indices since June 2014
Source: FE Analytics
The percentage of funds in the IA UK Equity Income sector holding BP has fallen by 11 per cent over one year with all of this coming in the first ninth months of the year and no change in the past three months with 40 per cent of funds still owning it, our data shows.
Brent crude bounced back to almost $68 per barrel by the beginning of May this year many to suggest the commodity was bouncing back nearer to its $100 levels.
Invesco Perpetual’s chief investment officer Nick Mustoe was one such manager to be vindicated during this period, saying a rebound was imminent, but now not so much following its recent falls.
One well-regarded manager in the IA UK Equity Income sector who expected the weakness to be short lived is Martin Cholwill who heads up the £1.8bn Royal London UK Equity Income fund.
“If you go back a few years you see that the five-year forward contract price has been a lot lower than the spot price and so I think there is scope in due course for it to bounce back to current levels,” he said back in January.
“If you look back at any analysis of marginal supply and producing oil to get an economic return, certainly current demand cannot be met at the current spot price of $45.”
The manager said as a result he was sticking with the big oil firms but this has clearly hurt performance with the two stocks making up around 10 per cent pre-crisis and 7.5 per cent in January but today just BP resides in the top 10 at about 2.8 per cent.
The manager is sitting in the bottom quartile of the sector this year having been top quartile for the previous three years and outperformed the index evert year for the past 10 full calendar years.
Performance of fund, sector and index since 2015
Source: FE Analytics
Jones says trouble in Greece and China – where the former is struggling to stay in the eurozone and the latter besieged with a slowing of its growth rate – are also stopping energy prices rise in general and improvements in how oil is ultimately used by consumers is also dampening demand.
“With two major consumers of commodities – Europe and China – both experiencing a slowdown in growth, and oil also being used more and more efficiently, headwinds remain,” he said.
Jones added: “Therefore, this equilibrium price between $40-$65 looks likely to last for some time, meaning oil does not represent a compelling investment opportunity.”