Striking it rich with oil is tricky

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Commodities - May 2013

Overshadowed by all the fuss around the dramatic fall in the gold price in recent weeks was a similar drop in the price of Brent crude oil, which plummeted by nearly 12 per cent in just a little more than two weeks.

It was a far cry from the early years of the past decade, when the oil price seemed to be on a steady, inexorable upward trajectory. Unlike gold, however, crude oil has a clear floor and ceiling on its price.

According to Richard Hulf, co-manager of the £110.8m Artemis Global Energy fund, if the price of oil drops below $90 a barrel, oil production would no longer be profitable for the major nations that make up Opec (the organisation of oil-exporting countries). So if the price falls, they will cut back on supply.

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On the other side, a high oil price will cripple many other industries, so if the price rises too high, the International Energy Agency will release some of its reserves to boost supply and lower the price.

So returns in the oil & gas sector are not likely to be driven by the price of oil any time soon, as its price is likely to remain within a prescribed range.

Another problem for the oil & gas sector is that it is becoming increasingly difficult to extract oil. Most of the easily reached oil fields are running dry, forcing firms to drill ever deeper and in ever more remote locations to find the commodity. This means costs are racking up.

Ed Legget, manager of the £584m Standard Life Investments UK Equity Unconstrained fund, says cashflows on the major oil and gas firms were poor as production slows and they replace existing oil fields with new, costlier sources of oil.

Mr Hulf says the sector now has a poor image for investors, with the ponderous majors lumped with exploration and production firms that have the reputation for ploughing money into increasingly risky ventures.

This combination of poor sector sentiment, slowing economic growth (that reduces demand for oil) and the plateauing of the oil price, has led the sector to underperform the wider market for the past few years.

While the FTSE 100 has risen 12 per cent in the past year, the oil & gas sector in the UK has fallen 5 per cent, with a similar pattern seen around the world.

Mr Hulf says the sector “needs to show how it is profitable and how it can control costs and get more disciplined on exploration, which is not what is happening right now”.

On his Artemis Global Energy fund, Mr Hulf looks for companies that have already made a discovery but are in the early stages of appraising and developing it. He sees these firms as providing the prospects for huge growth but without the huge risk of speculative exploration-only stocks.

Tal Lomnitzer, portfolio manager on the First State Global Resources team, also targets exploration and production stocks. He says the sector contains “a number of attractively valued, high-quality companies with responsible management teams and world-class assets”.