Friday, 3 October 2014

Oil Your Portfolio with Energy Exposure

Since the beginning of September, the benchmark FTSE 100 index has dropped over 5%. A buying opportunity, you might well think to yourself. But can we do better than that, by looking at some of the sectors within the UK stock market that have suffered more over the last month?

Bringing up the rear in performance over the last month with a 19% fall is the Food Retail sector – but this is for very good reasons, with the pressure on supermarkets from the German discount chains Aldi and Lidl, resulting in worsening profit performance from Tesco, Sainsbury and Morrisons. In my judgement, while there may be a value investing opportunity in these names, timing any investment is proving tricky, to say the least. 

I would rather focus on another large sector that has been some beaten up – the Oil & Gas sector, which has dropped over 7%. This has been principally driven by the precipitous drop in crude oil prices on both sides of the Atlantic, with Brent crude oil now costing a tad under $93 per barrel, $22 lower than the lofty height of $115 per barrel touched back in late June (Chart 1).

1: The Fall in Brent Crude and the Impact on the Oil & Gas Sector

Source: Author, Bloomberg

Why Could Oil & Gas Prices Rise?

With Winter approaching and the possibility of a cold, hard winter in the United States triggering greater demand for oil products such as heating oil, not forgetting the potential of disruption in supply of oil and gas from our Russian neighbours, we could at some point see a sizable rebound in global crude oil and natural gas prices. 

After all, OPEC nations are also keen to see crude oil prices stay above $90/barrel for their own, budgetary reasons, as oil and gas represent the vast majority of their government revenues. 

I suspect, furthermore, that global markets under-estimate the strength of the growth in long-term energy demand from the mega-sized emerging economies of China and India, which between them boast a population of over 2.3 billion who are currently using a mere fraction of the oil & gas per head that we consume per year in the Western world. 

Oil & Gas Exposure via Stocks, Sector ETFs

If you like this value investing theme, how best to get exposure? You could of course simply buy a few familiar large-cap oil stocks such as Royal Dutch Shell, BP or Total. 

Or you could buy an Oil & Gas Exchange-Traded Fund (ETF), such as the db x-trackers STOXX Europe 600 Oil & Gas ETF offered by Deutsche Bank’s x-tracker ETF division (code: XSER on the London Stock Exchange).  

Two Less Obvious Oil & Gas Investment Options

But I think that there are a couple of more intriguing investment alternatives that are a little less obvious, but which offer greater long-term potential. 

Firstly, there is the Ecofin Power & Water Opportunities Fund (code: ECWO on the LSE), an investment trust listed in London which is currently trading at a substantial 23% discount to its own Net Asset Value. To put this another way, you can buy exposure to £1 of stocks for only 77p! The Fund’s largest holdings are in oil companies, notably the US shale oil play Lonestar Resources and US oil infrastructure stock Williams Companies. In addition, the Fund also pays out a generous 4% dividend yield, a stream of dividends that has remained impressively consistent since 2005 when the Fund started. Since the beginning of this year, this trust has gained 32% to around 162p now, while the UK oil & gas sector has stagnated (Chart 2).

2: The EcoFin Power & Water Opportunities Fund Has Done Well

Source: Author, Bloomberg

A second way to take an interesting exposure to the oil & gas sector is through US-listed Master Limited Partnerships (MLPs), a particular tax-advantaged structure largely for infrastructure assets such as oil and gas pipelines which obliges the MLPs to pay out 90% of their profits in dividends. This high-yielding asset class has performed extremely well, with the London-listed Source Morningstar US Energy Infrastructure MLP ETF (code: MLPP on the LSE) up 16% in sterling terms to 7200p since April of this year. This ETF also also pays out a generous 6% dividend yield, to help investor returns (Chart 3).

3: Master Limited Partnerships Have Performed Very Well

Source: Author, Bloomberg

These are two intriguing alternatives to the more obvious oil & gas investment options which are well worth considering, particularly if you are an income-oriented investor. 


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