Don’t look to oil to make a cheap buck

Sanctions on Iran could see the price of oil soar by as much as 30 per cent according to the International Monetary Fund (IMF), but investors should be wary of piling into the commodity in the rush for a cheap buck.

A note from the IMF said the oil embargo, which was approved by the EU this week, would have a dramatic effect on the price of oil – 5 per cent of the global supply comes from Iran – and warned that threats of a blockade in the Strait of Hormuz could have an even greater impact.

Richard Hulf, manager of the Artemis Global Energy fund, said: "You can look at the oil price last year or any index that reflects it. The price of oil went up 20 per cent but the oil companies – large, medium or small – saw their share prices down 20 per cent."

"There is not necessarily a correlation between share prices and the price of oil."

Amandine Thieree, analyst at FE, thinks even professional investors will find it difficult to identify winning companies in this environment. She says: "Oil funds will find it difficult to spot which companies will cope with such an uncertain economic outlook."

"Much of the industry is at capacity and will require investment in new projects, but this hinges on credit being available, so despite expectations of rising oil prices in 2012, I think oil companies will struggle funding their investments and will probably be harmed by the upcoming year of volatility."

Share prices are hugely influenced by the level of risk that investors perceive to be associated with the companies they represent, and oil companies, Hulf says, are among the riskiest bets in many investors’ eyes.

"Oil and gas are regarded as the risky end of the spectrum," he continued, "so if the same thing applies this year it is no good just investing into an index that simply reflects oil and gas, you have to be specific and seek out a company that will do well within its own space."

He believes the best place to look for returns is among funds that have existing oil reserves and are also prospecting for new reserves.

He added: "We feel the best risk/return trade-off for investors is to look at companies which are not just producing oil but are somewhere in the middle – the sweet spot is when you have a company which has made some discoveries but doesn’t yet know how big they are. This type of company delivers the most reliable returns in this type of environment."

Cove Energy, Swedish company Lundin and Canadian firm Coastal Energy are all among his top picks, and are in a position where they have as yet unquantified oil reserves at their disposal. Artemis Global Energy is a relatively new fund, launched in April last year, that has performed relatively well so far – losing only 5 per cent while the IMA Specialist Sector in which it sits has lost nearly 10 per cent.

Energy funds en masse lost 18 per cent on average in 2011 while the MSCI World Energy index was up 0.9 per cent. This performance is actually worse than 2008 when the index was down 14 per cent and the funds lost more than 26 per cent.

Thieree rates Jonathan Waghorn’s Investec Global Energy highly, due to its proven long-term track record.

She said: "It is certainly a winner among the energy funds. It is the only fund to have beaten MSCI World Energy over the past seven years, returning 131 per cent while the index returned 113 per cent."