The price of oil has sneaked up this year. So does the sector offer good value?
Back in the dark days of January, when oil prices were languishing at just $33 barrel, few people expected to see oil reach $66 by the end of May. But it did. And earlier this week, it crept even higher. Yet as recently as April, analysts were predicting that oil prices might reach $60 "by the end of the year".
Many posters on the Fool's discussion boads made serious profits in the years leading to oil eventually climbing to the dizzy heights of $147 a barrel last July.
Riches for the few
But the spoils went to the brave. From tiny exploration-centred minnows to companies such as Tullow (LSE: TLW) and Soco International (LSE: SIA), there were enormous rises in share prices. Championed by an enthusiastic group of Fools on our various oil & gas discussion boards, Soco's share price climbed from around £3 per share to £24 per share in just three years. Some savvy investors got in much earlier.
Those investing in the oil giants saw much less by way of profits. Although BP (LSE: BP) and Shell (LSE: RDSB) generated very healthy profits and paid out handsome dividends, their vast downstream refining and retailing operations -- not to mention a series of self-inflicted banana skin moments -- kept their share prices far more stable.
And as the price of oil plunged downwards last year, the impact of the fall on oil-heavy portfolios was high. As ever, those who bought into the oil story too late found themselves sitting on significant losses.
What's more, not every oil exploration company will turn out to be a ten-bagger. Some are duds. Bad luck, dry wells, and indifferent management can all drag a company's share price earthwards. A number of Fools, for instance, have come to rue their investment in Canadian-listed Falcon Oil & Gas.
Where next?
Will the present spike in the oil price turn out to be just that -- a spike? This isn't the place to get into debates about 'peak oil' or the real size of Saudi oil reserves. But the Saudi oil minister has predicted a price of $75 by the end of the year, and few analysts think we're headed down to $33 again.
And in increasing its first quarter dividend from 13.525 cents a share to 14 cents a share -- despite a 62% fall in profits due to falling oil prices and the recession -- BP's board has signalled that it expects prices to remain above $60.
The debate, though, is finely balanced. An item in this week's Newsweek, for instance, cites two diametrically posing views on the question of when oil will get back to $100 a barrel. One expert says "very soon" -- meaning within twelve months. Another, pointing to spare production capacity and demand levels well below 2007, expects it to take much longer. The consensus view, apparently, is that oil will average $58 during 2010, and won't reach $100 until 2016. Personally, I'm expecting it to get there sooner.
Road to riches
Either way, the point is this: low prices are in the past, not the future. What's under debate now is how far they will rise, and by when. There may well be the odd dip in the price -- and we are coming up to summer, not winter -- but the world has changed a lot since the lows of January.
And the net effect is to turn the clock back to -- say -- 2003 or thereabouts. Of course, picking individual winners is a difficult task, especially when financing is hard to come by for even the largest of investors. Expect some losers. And it's perhaps too late for some stocks. Tullow, for instance, which traded as low as 427p back in November, is now around £10.
But if the prospect seems too daunting, and you'd rather ride safe-but-steady BP and Shell as your oil plays, don't forget specialised funds and ETFs.
Mark Dampier of Hargreaves Lansdown, for instance, recommends CF Junior Oils Trust, which invests solely in smaller oil and gas exploration and production companies -- such Soco, Tullow, Dragon Oil (LSE: DGO), and Bowleven (LSE: BLVN), which have all been favourites of Fool posters. While he cautions that prices might dip, for a long-term investment he's happy enough to put his own money there.
ETFs are another option for investors seeking diversification. Lyxor, for instance, offer the Lyxor DJ Stoxx 600 Oil and Gas ETF (OIL).
In short, while the oil and gas sector has already responded to the rise in oil prices, there's plenty of upside left for those prepared to accept some risk.
More on the oil sector:
Of the companies mentioned, Malcolm holds shares in BP.
