Now could be the time to buy oil stocks following US president Donald Trump’s decision to rip up the Iran agreement, according to Richard Robinson, manager of the Ashburton Global Energy fund.
So far markets have taken the decision in their stride as it had been signposted for some time although the announcement went much farther than was expected and was essentially a full pull-out of the deal – negotiated and signed before Trump took office – with no room for negotiation.
“It is highly unlikely the deal can continue without the participation of the US and a complete collapse is probable,” Robinson said.
From an investment perspective the biggest impact will be felt through exposure to the oil majors, which stand to benefit from a reduction in supply from Iran.
He noted that a worst-case scenario – which would involve strict adherence and policing of sanctions – could see as much as 700,000 bbld (barrels/day) removed from the market while at the other end, with ambiguous US guidance we could see 200,000 bbld removed.
“Although Trump would have ideally liked Europe to join him in re-imposing sanctions, the eventual effect is likely to be similar,” the manager noted.
“Europe currently imports between 500-600,000 bbld of Iranian crude and it is expected this number will drop by approximately 60 per cent. Iranian barrels can be easily substituted for Iraqi crudes.”
However, he noted that European companies such as Total and Eni may choose to stop lifting Iranian crudes altogether, for fear of being precluded from the US market.
But whatever the response might be, the impact is unlikely to be immediate, Robinson said, as companies with existing contracts will have between 90 to 180 days to terminate.
“Although this decision has been well broadcast, and the short-term pricing response may be flat or even negative, the implications for the market fundamentals are bullish – even if the escalating risk premium we are likely to see moving forward is ignored,” the manager noted.
“The market can hardly afford yet more oil to be removed from an already tight and tightening outlook.”
Performance of Brent crude spot price over 5yrs
Source: FE Analytics
While the Brent crude spot price is some way off its highs over the last five years, it has more than doubled since its lows in 2016.
Robinson said as such he has been bullish in relation to the oil price, even before the prospect of Iranian crude being pulled from the market became more likely.
“The rate of decline in inventories over the last 12 months has been unprecedented, despite the phenomenal growth in supply from the US onshore market,” he said.
“This supply growth has been eclipsed by a combination of strong demand growth, which was far above the International Energy Agency forecast at the beginning of the year, and supply being driven lower in a number of countries, most notably Venezuela.”
This is coupled with the number of projects delivering first-oil – oil from newly commercialised projects – expected to decline significantly next year thanks to the big fall in new project spending from 2014 to 2017 when the oil price appeared to be in freefall.
Robinson runs the $46m Ashburton Global Energy fund, which has a higher weighting to oil & gas exploration stocks and less in international oil and gas producers than its benchmark.
Over the past three years the FCA-recognised offshore fund has been a top quartile performer, returning 16.7 per cent, as the below chart shows. It has a clean ongoing charges figure (OCF) of 1.41 per cent.
Performance of fund vs sector and benchmark over 3yrs
Source: FE Analytics
Buying a dedicated energy equity fund such as Robinson’s Ashburton Global Energy is one of the five ways AJ Bell investment director Russ Mould suggests investors can get access to the energy space.
Second is by buying a UK equities tracker fund, with the iShares Core FTSE 100 exchange-traded fund (ETF) his preferred choice.
The ETF is large at £5.8bn in assets under management (AUM), but cheap with an OCF of 0.07 per cent and has both oil giants - BP and Shell – among its top five holdings. It has an overall weighting to the sector of 17.1 per cent. However, it is by no means a pure play on the sector.
The third option available to investors is to buy an actively-managed UK equity fund for similar reasons, said Mould.
“A lot of the top performers in the UK Equity Income category have low weightings in the oils so they have a big decision to take, as to whether to jump back in or not,” Mould said.
“One fund which already has big holdings in both BP and Shell is River & Mercantile UK Equity Income.
“They are the two single biggest holdings in the £286m collective, which comes with a 15 per cent weighting toward energy, a 3.7 per cent dividend yield and a 0.90 per cent ongoing charge.
Over the last five years the fund has been a second quartile performer in the IA UK Equity Income sector, beating both the average peer and the FTSE All Share, as the below chart shows.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
The fourth way to access the space is by adding a dedicated oil tracker fund such as the ETFS Commodity Securities ETFS WTI Crude Oil, which tracks the US benchmark West Texas Intermediate (WTI) or the ETFS Commodity Securities ETFS Brent Crude fund, which is the equivalent European oil benchmark.
Mould added: “Note that both trackers follow a basket of oil futures prices, not the spot price, and both use synthetic replication (derivatives) to achieve this.
“Besides movements in the oil futures, investors are also exposed to the roll yield and collateral yield for their total return on investment.”
The final option is to buy oil stocks directly, though this can be riskier. Indeed, so far, oil stocks have yet to fully warm to the rise in crude prices, as if to suggest investors do not believe the gains will last, he noted.
“The FTSE All-Share Oil & Gas Producers sector has gained just 4.4 per cent in 2018 – to rank it 13th out of the 39 industry groupings which make up the FTSE All Share – while the oil equipment & services sector is up by just 0.9 per cent, to place it in 20th in the performance rankings.
“Also note how the FTSE All-Share Oil & Gas Producers index trades at a multi-year low relative to the oil price – a calculation achieved by simply dividing the index’s value by the oil price.”