How to make money from rising oil prices

The oil price plays an important role in the global economy, but profiting from it is not always as easy as it appears. When oil prices are rising, investment opportunities abound. Read on to see what strategies you could use.

The value of investments can fall as well as rise, and you may get back less than you invested. Past performance is no guarantee of future results
Oil

Oil prices are back in focus. A combination of falling production in Venezuela, US President Donald Trump cancelling the Iran—US deal and ongoing global growth have all played their part in pushing oil prices higher.

With production tight and the Organisation of the Petroleum Exporting Countries (OPEC) unlikely to voluntarily increase supply it is possible that oil prices could make further gains from here. For an investor, what is the best approach to profit from the oil price?

Investing in oil — the spot price versus the futures market

In a previous note, we outlined in some detail the difficulties that investors can face when trying to own commodities, due to exchange traded funds (ETFs) owning futures rather than the physical product. Oil falls into this space — whenever you buy an oil ETF such as ETFS WTI Crude Oil (CRUD LN) you are getting exposure to a future. It is simply too difficult to store crude oil without incurring significant storage costs.

If the shape of the futures curve is upwards sloping, each time the near—term contract is rolled into one that matures at a later date, there is a loss of value known as a ‘negative roll yield’. When oil prices sell off heavily this can cause a significant drag on returns for investors that want to profit from a rebound in prices.

Investors in early 2016 found this out the hard way — the oil ETF rallied by 9% while the oil spot price was up more than 40%.

Chart 1: Oil ETF investing in futures versus the oil spot price

The good news is that as of May 2018 the oil futures curve is sloping downwards and in ‘backwardation’, which means that each time a futures contract is rolled it results in buying the oil exposure at a lower price.

Most people haven’t got access to professional charting (see Chart 2), but by going directly to the futures exchange, it is possible to see how the futures are being priced relative to the headline oil price. 

Chart 2: WTI Crude Futures curve (31.05.2018)

Invest in oil companies to capitalise on rising prices

While futures curves are attractive at present, they can easily change shape. However, all is not lost as the share prices of oil companies are predictably very highly correlated to the oil price.

FTSE 100 heavyweights Shell and BP offer one of the safer routes to getting exposure to oil and rising prices, but there are many other businesses that can see larger swings in value for the more risk—seeking investor.

Moving down in terms of market capitalisation, both Tullow Oil and Cairn Energy reside in the FTSE 250, while smaller outfits such as Premier Oil and Ophir Energy are in the small—cap indices. Smaller companies bring their own risks, with illiquidity, country risk and (usually) weaker balance sheets magnifying the gyrations of the oil price.

Rising oil prices also bring other companies and sectors into play. For example, US—listed shale oil producers are notable beneficiaries of higher prices. Businesses such as EOG Resources and Pioneer Natural Resources could continue to perform well if oil prices stay firm.

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