Oil firms are a healthy addition to a portfolio

Kathleen Brooks
THERE is a risk that once a company reaches a certain size it will over-stretch itself and as a result become bloated and less efficient. For the last two and a half years Anthony Hayward has successfully steered BP, the oil company he commands, away from this course. And, earlier this week he announced that the journey is not yet complete, and there is more streamlining to come.

The next three years will see further transformation for the oil giant. Hayward’s grand plan includes measures to shrink the company’s cost base by a further $3bn, adding to the $4bn of cost savings that have been made since 2007. Oil production is also expected to increase by one to two per cent per year. For a mature company such as BP, this type of fitness regime will give it the healthy sheen it needs to thrive.

Analysts at Evolution Securities point out that BP is now well positioned to perform well in the medium term: “In these uncertain times a leaner, fitter BP looks more secure than most stocks.”

It’s not just BP that looks ripe to perform strongly though. Its nearest rival, Royal Dutch Shell, should also do well. Although Shell is only implementing cost cutting measures now, both companies pay healthy dividends – yields for this year currently stand at 6.5 per cent. “Compare BP’s and Shell’s dividend yields to what you can earn in banks or on bonds, and that is a good return,” says Jonathan Jackson, analyst at Killick & Co.

For investors who want to protect their portfolios in an uncertain environment, then, Jackson says that oil stocks could be the best way to do it. Both demand and supply factors are supportive of a stronger oil price in the future: “Demand is being driven by emerging markets, but supply is also becoming more constrained and located in ever harder to reach areas, such as under the sea or in politically unstable areas such as the Middle East or Africa.”

Investors should remember that oil majors like BP and Shell are not necessarily a great link to the oil price. BP’s share price is 7 per cent lower than it was two years ago. This compares with the current oil price, which is 40 per cent lower than the peak of $147 per barrel in 2008. Pure exploration and production companies are a more effective play on a higher oil price, says Jackson. This includes companies such as Tullow and Cairn Energy, which are both listed on the FTSE 100.

But these companies can be more volatile in your portfolio. Because commodity prices are notoriously volatile, the more geared you are to the oil price, the riskier the investment. One way to disperse this risk is to invest in the oil and gas sector through an exchange-traded fund (ETF). Deutsche Bank’s db x-trackers provides an ETF on the DJ Stoxx 600 oil and gas sector, which invests in major oil firms and smaller production companies listed throughout Europe. This ETF also re-invests dividends, so, since BP and Shell make up nearly 40 per cent of the entire index, a long position can boost investors’ returns.

If BP’s Hayward can manage to keep progress on track, then investors should reap the rewards.