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DAILY TELEGRAPH (UK): White knuckle ride on the fuel rollercoaster ( 30 April 05


(Filed: 30/04/2005)


Brent prices hit highs and plumb the depths, so should you go for BP and Shell, or spread the risk, asks Ian Cowie


Up and down we go: should you ride the oil price rollercoaster?


Rising oil prices helped energy funds easily beat the average for all types of unit trust in recent years but falling prices this week prompted fears the upswing is over.  


Brent crude traded at less than $20 a barrel in 2001 but hit $55 last month before easing to nearer $52 this week. The effect on energy funds can be seen in the table on this page; 1,000 invested in Investec Global Energy five years ago would be worth 2,294 today - compared with only 1,013 in the average unit trust.


But can these funds - or shares in oil giants such as BP and Shell - keep on motoring? Or will the boom in this sector overheat and crash in the same way that technology, media and telecommunications (TMT) shares and funds flopped five years ago?


The merchant bank Goldman Sachs has forecast that soaring demand from emerging economies, such as China and India, plus limited supply may push the price as high as $105 a barrel. Goldman analyst Arjun Murti said: "Oil markets may have entered the early stages of what we have referred to as a super spike period."


Others argue that even the jargon is reminiscent of the bull market babble about "new paradigms" which preceded the bursting of the TMT bubble. But Tim Guinness of Investec claims there is still plenty to go for. He points out that, between 1990 and 2000, TMT share prices increased tenfold on average - whereas the constituent stocks of the Morgan Stanley World Energy Index have not even doubled since 1998.


Mr Guinness said: "If you think about what this oil price rise is doing to oil company profits, the rise in their equity valuation is very modest.Putting it very simply, take an average oil company's costs as $15 per barrel - this includes exploration costs of, say, $8; production costs of about $6; and overheads of $1. Its profit before tax and royalty is $10 at $25 per barrel, which was the average price between 1986 and 2002 after inflation.


"However, profits rise to $25 at an oil price of $40 and $35 at a $50 oil price. These are profits rises of 150 per cent and 250 per cent respectively.


"If - and I accept it is only if - oil prices move permanently to more than $40,then we should expect over time oil company shares to rise by a similar percentage."


Simon Ward, an investment strategist at New Star fund managers, is more cautious. He said: "It is plausible that the oil market will tighten further as rising energy needs collide with limited supply expansion from currently planned projects and depletion of existing fields.


"But oil demand also fluctuates with the global business cycle, which is now beginning to turn down. The near-term risk to prices may therefore be shifting to the downside, with the forecast 'spike' more likely to occur later in 2006 or in 2007 as global economic growth accelerates again."


Similarly, John Greenwood, chief economist at Invesco Perpetual warned that demand may fall if the price rises too high: "The current price could prove temporarily self-correcting if it were to precipitate a period of markedly slower world growth or even a recession, thereby dampening global demand for oil.


"However, the fundamentals of the oil industry and the prospects for global energy demand suggest that even if there were improvements in the short-term inventory position and an easing in geopolitical tensions - as has been the case recently - the world is facing a very different outlook for oil than was assumed even one year ago."


Richard Miles, a director at Fidelity Investments, said: "The factors that caused the oil price to rise steeply are still in place.''


He added: "Demand remains very strong, particularly from China, which consumes 6m barrels of crude each day, nearly 10 per cent of total consumption, and China's appetite for crude is forecast to rise to 8m barrels per day by the end of next year."


The Jupiter Income Trust has nearly 10 per cent of its assets in BP and four per cent in Shell. Anthony Nutt, manager of the fund, said: "I continue to believe the profits outlook for these companies remains good."


Which prompts the question whether investors might not do better to buy shares in BP and Shell, rather than energy funds. BP was trading at about 532p this week, compared with a five-year peak of 657p in 2000, while Shell now trades around 468p against a five-year peak of 633p in 2001. The stocks yield 2.9 per cent and 3.6 per cent respectively. Shareholders avoid unit trust initial charges of more than five per cent and annual management fees of about 1.5 per cent but do not benefit from a diversified portfolio of stocks held within a managed fund.


Against that, enthusiasts for direct shareholdings in this sector may decide that global giants such as BP and Shell provide a form of diversification in their own right.


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