3rd November 2015
Juliet Schooling-Latter, Research Director
If you are anything like me, you get too many emails every single day and, in a futile attempt to keep on top of them, have a 'to read later' file on your computer. So it's always good when one hits your inbox that has an interesting enough title that it gets read immediately.
One such email I received recently was entitled: “Don’t be fooled: The oil price has changed for a generation.” It was from Chris Taylor, Head of Research at Neptune (and manager of Elite Rated Neptune Japan Opportunities). He doesn't believe the oil price will return to its old equilibrium ($80-$90 per barrel) for a decade or two and says that Neptune's analysis suggests that the break-even point could be half this amount because US shale production has much lower costs and improving productivity.
There have been many market movements over the past couple of years, but the collapse in oil is one of the most notable and remarkable. In June last year it was priced at more than $115 per barrel. Today it is just $47. That is in spite of several wars emerging in Africa and the Middle East, which would have normally added a 'risk premium' to its price.
Oil, energy and mining stocks are one of the few 'contrarian' plays left in the market. They are unloved by pretty much everyone. So, if the equilibrium is to remain lower for a significant period of time, can any money be made out of them, or are they what is known as a 'value trap'? Earlier this month, several investment bank analysts argued it was time to get back into them when the FTSE 350 Oil & Gas Producers index, having fallen by 34% since its peak in June last year, bounced back by 18% in the course of a few days*. However, the rise soon faltered and the index has been going sideways since.
The people at Allianz Global Investors believe that the big oil majors look a decent bet. As the oil price has fallen their response has been to cut capex and importantly, their dividends are only 20% of their cashflows at near-term oil prices. Industry-wide cost deflation is rampant and Allianz believe that they have scope to cut their costs further, if needed, so that investors should feel confident that their dividend income (6%+) is secure in a world of very little income. Management teams are focused on returns to shareholders and, unlike the mining stocks, still have many more levers to pull to protect the shareholder.
Steve Davies, manager of Elite Rated Jupiter UK Growth, agrees with Neptune that, given the current supply glut and the rapid productivity improvements being made by the US shale gas industry, the oil price could be stuck below $60-$65 for some years to come. He doesn't think mining companies are a recovery story just yet, but is keeping an eye on the sector and has said that it may be a theme that comes into his fund in 12-18 months' time. In the mean time, he is trying to make money out of low oil prices in a different way. For example, he holds Thomas Cook. Steve calculates that their fuel bill could reduce by as much as 45% by 2017 in dollar terms and, whilst some of the savings will be passed on to consumers, their profits should also see a significant boost. He also likes WHSmith, which he thinks should benefit if fuel savings are passed on to consumers in the form of lower prices. WHSmith might not seem the most obvious beneficiary of this, but the reality is that its travel business now accounts for nearly 60% of group trading profit and its airport shops are a very substantial part of this.
My view is that oil prices are unlikely to go much lower, but they could indeed stay at this level for some time, trading between a range of around $45-$60 per barrel. I just can't see a catalyst for change at the moment.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Juliet's views are her own and do not constitute financial advice.
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