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Can you profit from the rising oil price?

Royal Dutch Shell shares have been volatile since it admitted it had problems replacing its oil reserves last year.

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Petrol prices roar away, but oil stocks are stuck in the slow lane. Emma Wall looks at the investment case.

By 21 Jul 2013

Feeling the effects of inflation at the pump? That’s because the oil price has risen steeply. Since early June, Brent crude has risen from a little more than $100 to reach $108.60 a barrel. Overall inflation rose to 2.9pc last week from 2.7pc the previous month – largely because the increase in the price of oil.

But despite the climbing price of oil, the value of oil stocks – and funds that invest in them – has so far failed to enjoy similar gains. But that could change.

BP, a share widely owned by popular funds in Britain, is still very much dealing with the fallout of the Gulf of Mexico oil spill. The full cost of the disaster cannot be calculated until next year. Royal Dutch Shell shares have been volatile since it admitted it had problems replacing its oil reserves last year. BP and Shell make up 77pc of the British energy sector between them.

These two mega caps are not as affected as some oil companies by fluctuations in the oil price as their business is split into two parts – upstream and downstream.

Upstream business is the production of crude oil; these revenues are affected by fluctuations in the oil price. Oil companies who only have upstream business, such as BG Group, therefore benefit when the oil price rises.

However, BP and Shell draw revenues from downstream business, too, which is the refining and marketing of oil, right down to selling petrol at the pump. Neither Shell nor BP produces enough oil to service its downstream business, so they have to buy crude in – at whatever the inflated price is.

If you think the oil price has farther to climb, pure exploration and production companies such as BG Group and Tullow Oil are your best bet, although oil analyst Iain Armstrong at Brewin Dolphin favours BP.

“So far this year, BP is the only oil company that has outperformed the stock market,” he said. “I think that all the negativity surrounding the Gulf of Mexico disaster is already priced into the shares.”

Mr Armstrong said that BP and Shell had spent too much money on the exploration and development of new mining sites. They came in over budget – but he considers BP a strong enough company to recover, and it has an attractive yield of 5pc.

Ben Yearsley of rival broker Charles Stanley agreed.

“Lots of the big equity income funds have BP and Shell, and they are probably happy with the income they are receiving while the share price treads water,” he said.

Medium term, the likelihood of the oil price continuing to rise is slim: there have been large discoveries of oil in the United States, and Saudi Arabia – currently the biggest oil-producing economy – has spoken openly about its desire to keep the oil price stable.

But Brian Dennehy of FundExpert said that despite this, oil stocks looked very good value. In price-earnings terms – a measure of relative value – they are at a 40pc discount to the stock market as a whole.

“They rarely get this cheap, perhaps on six other occasions in the last 50 years,” said Mr Dennehy. “The other positive kicker for UK investors is currency. All the oil action takes place in dollars. If the dollar continues to appreciate against sterling, which we expect in some scale, this makes oil stocks doubly attractive for UK investors.”

He said investors keen to exploit the cheap oil companies should consider funds such as Artemis Global Energy and Investec Global Energy.

Mr Yearsley also recommended the Artemis fund, as well as Guinness Global Energy.

“Long term is only going one way, up,” he said. “The world’s population is increasing and becoming more middle class and prosperous, and are therefore buying more cars and using more oil. China has about 75 cars per 1,000 of population. The UK has about 30 million cars with a population of 70 million – if China even comes close to that, the petrol price will soar.”

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