Thursday 29 September 2016

Is it time to protect your investment from oil?

It's not just investors in energy firms who need to worry about the tanking oil price, writes Louise McBride

Published 07/02/2016 | 02:30

Cartoonist: Tom Halliday
Cartoonist: Tom Halliday

The crumbling oil price is starting to drag more and more investors down with it as the ramifications of the oil crisis spread.

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Although shareholders in big oil companies have clearly been amongst the hardest-hit by the tanking oil price - which recently fell to an almost 13-year-low - many investors in chemical companies, logistics businesses, aircraft engine makers and high-yield bonds are also feeling the pain. With the oil price hovering around the US$30 a barrel mark early last week, and warnings that it could fall to as low as US$10 a barrel, there could be more losses to come for many investors.

Losers

Major oil companies, such as British Petroleum (BP), Royal Dutch Shell, Exxon Mobil and Chevron, are amongst the first to be hit when oil prices drop. So too, clearly, are those who own shares in these companies.

The shares of BP dived by almost 9pc last Tuesday after the oil producer announced an annual loss of €6bn (US$6.5bn) - the worst in its history.

Many oil and exploration companies, such as Tullow Oil, Cairn Energy, Petroceltic, and Apache have also been in the firing line. Earlier this year, Tullow Oil said that it expected its profits for 2015 to be significantly lower than 2014 due to the slump in oil prices. The company's share price has more than halved over the last year.

Investors in the oil services industry, which includes the likes of Petrofac and the Wood Group, have also lost money.

"Their prices can be slower to react than the energy producers, but their health depends on the state of the energy industry," said Adam Laird, head of passive investments with the London investment firm, Hargreaves Lansdown.

Losers aren't just confined to the oil industry. Low oil prices are normally a boon to chemical companies because oil is usually a major raw material for them. However, the chemicals giant BASF warned recently that it expected its earnings for 2015 to dive by almost a fifth. It cited the hit taken by its oil and gas division on the back of falling oil prices as one of the main reasons for this.

The British chemicals firm Elementis issued a profit warning last June and blamed the oil sector's woes in the United States for much of its problems.

The low price of oil has taken a heavy toll on Rolls-Royce's marine engine business, largely because of falling demand from offshore energy companies. The aircraft engine maker issued its fourth profit warning in just over a year last November. It has cited low oil prices as one of the reasons behind its profit warnings - because of the uncertainty created for many of its markets and customers.

Investors in high-yield bonds are also vulnerable. "Energy firms accounted for over 10pc of the global high-yield bond market last year, but this has reduced as bond values have dropped and some issuers have gone under," said Mr Laird. "There could be more if prices continue to fall."

Those who have poured money into niche investment funds could also suffer, particularly if that fund has exposure to oil-exporting countries, such as Russia, Brazil and in the Middle East.

"Some countries, including Russia and Brazil, are dependent on oil markets," said Mr Laird. "Whilst few investors directly own shares from these countries, they may own them through emerging-market equity funds."

What should losers do?

"It is rarely wise to sell an investment straight after a major price fall," said Mr Laird. "If you are already exposed to oil, don't panic. The biggest rebounds often come after a sharp fall.

"This can be a chance to top up at lower prices, but be careful. Prices could remain at this level for some time. Take the opportunity to review your choices. Oil prices are volatile and investments with exposure to oil can be risky -so if you are uncomfortable owning them in the long term, consider a change."

There will always be good and bad years when investing for the long term.

"Investors tend to invest when things are already going up and pull the plug after a big loss," said Eoin McGee, principal of Prosperous Financial Planning. "This costs them in the long run and they miss out. Don't change your plan unless your circumstances have changed."

Your age will also have a big say on any decision you make about an oil-exposed investment.

"If you are relatively young and time is on your side, there's no reason to sell - as all you're doing is locking in the loss," said Russ Mould, investment director at the British stockbrokers, AJ Bell. "On balance, oil should come back at some stage, so you'll have the time to come through the volatility. However, if you're in a position where you'll need the money in your investment in the next year, you may need to protect yourself by raising cash."

Investment opportunities?

Those who believe that oil prices have hit a bottom may be looking for investment opportunities which will allow them to make money - should prices pick up.

An exchanged traded fund (ETF - essentially, a basket of shares) which invests in oil and energy could be worth considering.

The iShares Core FTSE 100 ETF is one tipped by Mr Laird. "Energy and mining are important sectors in the FTSE 100," said Mr Laird. "However, the FTSE 100 is much wider than just these markets - spreading the risk if current conditions persist."

A riskier option, according to Mr Laird, is the iShares Oil & Gas Exploration and Production UCITS ETF. "The oil and gas industry has been withholding investment and shelving projects in response to low prices," said Mr Laird.

"This ETF lost a lot of value last year, but invests in almost 100 oil-exploration companies globally. It's a riskier choice - but it could benefit if oil once again rises."

The shares of major oil players, like BP and Royal Dutch Shell, could also be worth buying, according to Mr Mould. Both companies pay a high dividend yield (that is, the dividend expressed as a percentage of the share price).

"If you are convinced that the dividend yield of these companies is safe, that the oil price will rebound and that the share price of these companies will go up on the back of that, these could be good shares to buy," said Mr Mould.

Investors can get good value for their money by buying shares in these large oil companies - because of the attractive dividends, according to Aidan Donnelly, senior equity strategist with Davy.

As Tullow Oil's share price is less than half of what it was this time last year, now could be the time to snap up cheap shares in the exploration company - as long as those shares don't dive any further.

"For the more speculative investors, oil explorers, such as Tullow and Cairn, could be worth considering," said Mr Mould. "You could also look at oil-equipment companies, such as Petrofac, the Wood Group and the Weir Group.

"The big oil producers have said they'll order less oil equipment because of the low oil prices - but if the price of oil goes up, producers will make more profits - and that will feed through to equipment orders."

Winners

There are those who believe that oil has yet to hit the floor and will continue at record lows for some time. And low oil prices are good news for big consumers of oil, such as airlines. So shares in profitable airlines could be worth snapping up.

"The profits of airlines such as Ryanair and Easyjet have been rising strongly and that's been helped by low oil prices," said Mr Mould.

Ryanair announced last week that its profits for the last three months of 2015 had more than doubled.

Logistics companies (that is companies which transport and store oil) and pharmaceutical companies (who use oil as a raw material) can also do well when oil prices are low - although they don't always benefit.

The German pharmaceutical giant, Bayer, saw its profits jump by about a fifth in the third quarter of 2015, according to the company's latest results. However, other chemical companies have been hit by the poor oil prices.

Fees from storing oil have risen as unwanted crude fills tanks around the world - which has put more money into the pockets of logistics companies. However, low prices can also reduce the amount of oil being shipped and transported, particularly if production is cut and more companies go out of business - and this can put logistics firms under pressure.

Is the worst over?

It's anyone's guess whether or not oil prices will continue to slide - and for how long.

"You could argue that the worst is over with oil prices," said Mr Donnelly. "As we move on, we may see the oil price move up - not by much, but it's the direction that's important."

Many oil-price-weary investors will be hoping he is right.

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