Oil prices at rock bottom: Shares in energy companies plummet - should you purge your portfolio?

With oil prices low, energy companies are struggling to survive – should investors be buying?
Oil prices have fallen to their lowest levels since the financial crisis. The price of Brent crude went down to $42 a barrel earlier this week, before recovering a little.
The news is shocking because, when oil prices were first slashed from over $100 a barrel to around $50 last June – due to the fact that there is so much being pumped out of the ground and not enough industrial demand in the world to use it all – people thought it would be temporary.
It would be over by Christmas, experts said, as Opec – the group representing oil producers, which is controlled by wealthy Middle Eastern nations – would soon decide to cut production, thus reducing supply and pushing prices back up again.
This is how Opec has behaved over the last decade, as the group of oil-rich countries collectively decided to produce only enough crude to keep prices around $100.
Those hopes have since faded. Saudi Arabian officials have spoken about how they are keeping production high so that lower prices will be damaging to other countries that have been ramping up their production of the black stuff – chiefly the USA.
Now, one year on, oil is still priced under $50 per barrel. Unsurprisingly, this has been tough for oil companies, which rely on high prices to remain profitable. So should investors be thinking of purging their portfolios of oil?

DO I HAVE OIL IN MY PORTFOLIO?

Probably a small amount. Many investors will unwittingly have some exposure to energy companies.
Many of the world’s biggest oil companies sell their shares on the UK’s main FTSE market, even though they operate predominantly overseas in places like Ghana and Brazil.
Anyone with a FTSE 100 index fund or other market tracker (which invests in each of the hundred companies on the market) will have some of their money invested in six companies whose main business is oil and gas. These are BG Group, BP, Petrofac, Royal Dutch Shell, Tullow Oil and Wood Group.
Some of these have been popular choices for active fund managers. For example, there are over 220 investment funds with BP among their top ten largest holdings. Royal Dutch Shell is in 60 and BG Group in 90.
These include everything from standard UK equity funds to ethical investments, such as the Invesco Perpetual UK Growth fund and the Kames Ethical Equity.
All of these statistics are from FE Trustnet, and show how even investors without dedicated energy funds in their portfolio may have some investments in oil companies.

HOW HAVE THEY DONE?

The mere existence of these companies on the FTSE 100 has been a big pain for people with index funds this year. The FTSE has been dragged down nearly 10 per cent in the last 12 months, partly because of price falls at oil companies – so every investment of £1,000 in one of these index funds will have lost almost £100.
Among individual oil producers, the biggest on the market is Royal Dutch Shell, and its share price has unsurprisingly performed terribly in the last year.
The shares have fallen 36 per cent since last August, so £1,000 invested will have been reduced to just £640. Other oil companies have performed even worse. For example, Tullow Oil is down nearly 75 per cent. This shows the importance of diversification in a portfolio, so a fall in value of one company’s shares can be offset by price gains in another bunch of shares.

WHAT WILL HAPPEN NEXT?

Fund managers often like to say that share price falls are a “buying opportunity” – in other words, a chance to buy shares at a cheaper price than they are usually.
However, with oil companies, opinion remains divided. No-one knows where the oil price will go, and estimates range from $30 to $70 over the next several years. Future prices depend on a number of factors, including whether Opec cuts production to reflect the level of demand for it. At the moment, it seems as if Saudi Arabia is prepared to grin and bear cheap oil, and even though this is having an impact on its economy, it seems unlikely that it will agitate for higher prices.
“The drop in oil over the past couple of months is unlikely to cause policymakers in the Gulf countries to panic,” says Jason Tuvey of Capital Economics.
“Whichever way you cut it, the Gulf economies are in a far stronger position than the majority of other oil producers and are likely to shrug off renewed calls from smaller members of Opec to cut production in order to shore up prices.”

OIL COMPANIES FIGHT BACK

But although supply and demand is often the main factor which affects commodities, lately the sector has been facing a lot of negativity in general. Everything from copper and gold to diamonds has fallen massively in value. Investors have been selling out of commodities in a kind of herd behaviour. Some argue the price falls don’t necessarily reflect the true outlook for each.
Moreover, oil companies have been forced to change their businesses during this last year. Royal Dutch Shell, for example, is laying off thousands of workers and its chief executive said he is preparing the company to try and be profitable if there is an extended period of low oil prices. This may not even come to pass – one year from now, oil prices could be back at $100 again.
One investment manager who is looking at putting clients’ money into oil companies is Michelle McGrade of TD Direct Investing. She thinks these stocks have suffered from “indiscriminate” selling, and that the businesses can adapt to lower revenues.
“Oil prices have come down, but companies have cut their costs and are restructuring,” she says. “I think oil company stocks have been sold off indiscriminately and when that happens I want to pick active fund managers who can look among these rich pickings.” McGrade has not decided which investment funds she will go for, but is likely to choose one dedicated to energy companies.
In the meantime, some experts say it is too soon to buy shares in oil companies. Although their chips are down, they could fall further and be even better value for those inclined to buy some.
“Investors looking for value in the sector may be forced to wait longer, as the outlook for commodities remains poor amid Chinese weakness, dollar strength and general over-supply,” says Rebecca O’Keeffe of Interactive Investor.

Related articles