Will oil companies be among this year's best performers?

The oil price is something most of us probably only ever think about as we're filling up the car. Figures of US$30, $40 or $50 a barrel on the nightly news are all well and good, but it's the 102, 105, 108 pence per litre at the pump that really gets our attention.

In that context, you may have noticed your costs creeping up over the past few weeks, after several months of declines. Instead of bemoaning the increase, however, it might be worth thinking about the opportunities from an investment perspective.

If oil is finally on the verge of stabilising after one and a half years of extraordinary falls (Brent Crude is down from US$114 a barrel in June 2014 to below US$30 in January this year), energy companies could turn out to be among this year's strongest performers globally.

Returns year-to-date have shown positive trends. The MSCI World Energy index is up 13.8% versus MSCI World's 3.6%1. This is a stark reversal on 2015, where the energy index fell 18.3% against a 4.9% gain in global shares2.

As this difference illustrates though, oil, and energy more broadly, is a volatile game. There's money to be made, for certain, but there's also money to be lost. It's important to understand any number of economic and geopolitical upsets could derail the sector's modest recovery, and getting the timing right can be crucial.

In my view, however, the mid-term outlook is now stronger than we've seen in some time. And short-term price falls like the ones seen last week could present good buying opportunities.

What happened last week?

The price of Brent dipped last week having earlier exceeded US$45 a barrel – still quite a recovery since the start of this year. Energy stocks quickly followed suit. The reason was an important meeting of most of the world's biggest oil producers, which took place in Doha, Qatar.

The goal of this meeting was for major oil suppliers to agree to 'freeze' their production at the levels they produced in January this year.

Unfortunately, this was not successful. Iran, which has been prevented from exporting oil for years, only had its international sanctions lifted in January. They want their production to return to pre-sanction levels before they commit to any limits. Saudi Arabia refused to sign any agreement if Iran did not and so the talks fell apart.

The deal was intended to go some way to redressing supply–demand imbalances that have been pushing down oil prices for the better part of two years, and both the commodity's futures and energy equities had climbed in anticipation. When an agreement was not reached, they naturally retreated slightly.

Regardless of the meeting's disappointing outcome, however, supply and demand do look to be starting to come back into balance. In the U.S., for example, production has been massively curtailed. The number of oil rigs operating in that country as of last week was 431 – some 500 fewer than a year ago3.

Furthermore, sustained low prices have put such pressure on oil companies that we have seen significantly reduced spending and improved productivity measures in order to survive. So even small increases in the oil price now should have a positive impact on earnings.

Put simply, many of the fund managers I speak to agree there's a price point below which oil cannot sustainably be produced and it becomes cheaper to leave it in the ground. Many also argue we reached that point earlier this year and a natural rebalancing is becoming inevitable. So with or without the Doha agreement, there are convincing indicators oil prices throughout 2016 will be consistently higher than they were in 2015.

How to invest

For the average investor who wants to get exposure to this potential growth but doesn't want to become an expert in geopolitics, economics and commodity futures, an actively managed fund is a good way to go.

Successful investing in energy is as much about avoiding the losers as it is about picking the winners. You want to find a fund manager with the expertise to do both. Our preferred fund in this space is Guinness Global Energy, which is on the Chelsea Selection list. Its performance relative to its peers has been consistently good and the lead manager Tim Guinness and his team are some of the most experienced energy investors in the UK.

So next time you roll your eyes at your rising weekly petrol bill, consider whether there isn't a sliver lining to that oil-coloured cloud!

By Darius McDermott, managing director, Chelsea

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. Darius’ views are his own and do not constitute financial advice.

1 FE Analytics, MSCI World Energy, MSCI World, TR in GBP, 31/12/2015–25/04/2016, accessed 26/05/2016
2 FE Analytics, MSCI World Energy, MSCI World, TR in GBP, 01/01/2015–31/12/2015, accessed 26/05/2016
3 Baker Hughes, US Rig Count Overview.
Published on 27/04/2016