MARKET COMMENT
Trouble For The Oil Bubble

By David Kuo (TMFDragon)
October 11, 2004

One of the surest signs that an investing bubble may be about to burst is when a new fund or tracker is launched to follow the relentless rise of a particular asset. Recent examples include tech funds and a fund tracked the price of gold. After all, it is always much easier to try and sell shares in a rising star than to try and flog a dead horse!

Today, a new fund that specialises exclusively in quoted small and medium sized oil producers and explorers begins trading. Junior Oils Trust will invest in expanding smaller UK and overseas companies involved in the oil industry. However, larger outfits such as Shell (LSE: SHEL), BP (LSE: BP.) and BG Group (LSE: BG.) will be purposely excluded.

The idea behind the trust was devised by investment guru Jim Slater, who reckons that the era for cheap oil is at an end. He also believes that major oil companies will be prepared to pay handsomely for solutions to their depleting oil reserves. Hence their deliberate exclusion from the fund.

Interestingly, many experts do not agree that we are about to run out of oil, either now or in the near future. They point to figures that show current oil supplies are more than adequate to satisfy demand. This is even with the well-publicised threat of terrorism and insurrections at various oil installations hanging over the oil industry.

Consequently, some pundits believe that the price of a barrel of oil should no more than in the high $20s a barrel range. This begs the obvious question as to why oil is currently trading at over $50 a barrel. Again, a number of oil experts are firm in their views that the high price of oil can be attributed largely to speculation.

In my view, oil prices could fall for a couple of reasons. Firstly, continuing increases in world oil inventories should cut the so-called "fear premium" that has been built into crude prices. Secondly, any softening in oil prices could quickly dampen the enthusiasm of oil speculators, triggering their mass exodus and this could result in a swift correction of prices.

Nevertheless, those behind Junior Oils Trust reckon that a major oil discovery could have a disproportionate effect on the share price of smaller oil explorers. Indeed, major discoveries have already boosted shares in the likes of Cairn Energy (LSE: CNE) and a number of other smaller oil companies. However, the fund also recognises that not all oil explorers will be successful in their endeavours. Therefore, it will invest across the sector to minimise risk and increase the chances of finding a few big winners.

Investing in a fund like this obviously involves less risk than picking one or two companies directly. However, I can't help feeling that its launch is a classic warning sign of a toppy sector.

David owns shares in Shell.

More : Oil Shares – Good To The Very last Drop | Shell Shock Value