COMMENT
Five Ways To Invest In Oil

By David Kuo (TMFDragon)
September 19, 2005

Rising oil prices have been a boon to investors who had the foresight or luck to get in early. Those who missed the boat are now wondering if they may have missed the last ferry too. Only last week, a friend, who has no exposure to oil, asked me if oil prices can carry on rising - as if I have a clue! And almost in the same breath he asked how he can play the oil sector now.

Perhaps his second question provides as good a clue as any as to whether oil is still a buy. After all, private investors are notoriously bad at market timing, and have a habit of buying at or near the top! Consequently, it may pay to tread carefully. But if you still find oil attractive here are five ways to play the sector.

Integrated oil companies

With revenues greater than the GDP of some oil-producing countries, buying shares in oil majors such as BP (LSE: BP.) is equivalent to acquiring a small stake in an OPEC nation. Oil majors are also known as integrated oil companies, which mean they have interests in oil exploration, refining and transportation.

In times of high oil prices, oil majors with substantial exploration interests tend to fare well. But when oil is less pricey, 'downstream' outfits, those with significant refining operations, may do better. Over the last two years, BP has risen by over 50%.

Smaller oil companies

Booming oil prices have done wonders for the shares of small oil explorers in the last couple of years, and many of these companies have become private investor favourites. They have been able to pick up stakes in fields that are considered too small by the oil majors and some, such as Cairn Energy (LSE: CNE), have been hugely successful in discovering oil while others like Regal Petroleum (LSE: RPT) have been far less fortunate, with shareholders being hit by heavy losses when a key prospect was deemed not to be commercially viable.

Some small oil companies have little or nothing in the way of current oil production and only minority stakes in a few exploration projects in politically unstable areas. Often it is uncertain how much oil is present, how much it will cost to extract and how much revenue will be received for each barrel. All this makes small oil exploration companies some of the most speculative investments on the stock market.

Oil Funds

Oil funds can be a better way to gain exposure to the oil and gas sector if you only have a modest amount to invest. For example, Junior Oils Trust, which was launched in October last year, aims to spread the risk of investing in oil explorers through diversification. It has interests in a range of oil prospectors that include JKX Oil & Gas (LSE: JKX) and Melrose Resources (LSE: MRS) - both companies have exposure to Eastern Europe. It also owns shares in Sterling Energy (LSE: SEY), which is drilling for oil in the Gulf of Mexico, Madagascar and Cameroon. Junior Oils Trust has returned 40% since its launch last October.

Oil Trackers

Oil trackers are another recent innovation that allow investors to track the price of oil directly. Through Oil Securities (LSE: OILB), investors can access the oil market without having to take physical delivery of a barrel of oil. Each oil share is bought at the market price for a barrel of oil and matched against a physical oil contract.

Oil Securities is ideal for oil players who want to back their hunch over the direction of oil without taking unnecessary risks with options and futures contracts. However, the shares are priced in dollars, so UK investors are exposed to currency movements. There also a 1% management fee to take into account.

Alternative fuel

Finally, instead of chasing a runaway bandwagon, why not consider biofuels. Companies such as D1 Oils (LSE: DOO) and Biofuels (LSE: BFC) aim to produce diesel from vegetable oils such as palm, soya and rapeseed. Additionally, boost for the industry may be provided by the European Union. It is promoting the use of biodiesel, and has set a target that biofuels make up 5.75% of gasoline and diesel consumption by 2010.

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