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How will you bet on big oil?

Putting the ‘B’ word to one side – oh how we long for that day – is there a more difficult question for investors in the UK market than the future of oil?
 
Okay, perhaps the future of High Street retail, but it’s close!
 
The energy sector makes up 13% of the FTSE All-Share thanks to super-sized BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB), as well as a host of minor exploration companies that have thrilled, enthralled, and impoverished retail investors for decades.
 
Consider too that the majors look depressed by many traditional measures. They both sport dividend yields of over 6%, for instance, which in an era of near-zero interest rates seems akin to striking oil in your own backyard. Were the price of BP and Shell’s shares to rise to bring their dividends down to a still-sizeable 4%, for example, then – all things being equal – the energy sector might swell to comprise a fifth of the London stock market.
 
The obvious question is why are the shares sporting such a high yield in the first place?

BP and Shell earn the vast majority of their money overseas, and with the B-word having bashed the pound into a shrunken version of its former glory, that foreign money is worth a lot more when repatriated back home.
 
Shouldn’t investors be backing up the tanker to buy the majors?
 
It’s not so simple.

Blame it on the Brexit?

For one thing, even as it has juiced the profits of UK multinationals via the weaker currency, Brexit has also depressed the appetite of both overseas and domestic investors to own British shares.

This effect is much more marked with those domestic shares expected to suffer in a disorderly exit from the EU, certainly. But the UK market can’t languish at the bottom of the world’s investors’ wish lists without all our companies taking a hit – not in this ETF-flow driven age. Fewer buyers for British shares equals lower demand and lower prices.
 
Yet energy would be a controversial sector even without our political turmoil – shares in US behemoth Exxon (NYSE: XOM) are languishing near a five-year low, too, for example.
 
It could be worse. Oil prices have more than doubled since the lows they hit in early 2016, and oil companies’ share prices have rallied accordingly.
 
But why haven’t oil stocks rallied more, given all the money they’re minting and the operational gearing enjoyed by commodity companies?
 
The answer must be that the market doubts these times will last.

Two countervailing forces

It’s the future that is uncertain when it comes to energy, not what is happening right now. And as a discounting machine, the market can’t help getting the willies.
 
Indeed, anyone who keeps up with global news should have concerns.
 
I see two overriding issues.
 
Firstly, consider that earlier this month numerous missiles launched from drones crippled Saudi Arabia’s oil facilities. Half the country’s production was shut-off, and the oil price saw its biggest spike in 30 years.
 
Saudi Arabia supplies 5% of the world’s oil demand. Yet despite the disruption – and even more so the revelation that just a couple of drones could wreak such havoc, and presumably could again – half of that price spike was retraced within days.
 
Prices remain elevated, but the market doesn’t seem to be overly panicking.
 
True, the outages were quickly tackled by Aramco, the Saudi state-run oil giant.
 
But I think more important is the emergence over the past decade or so of the US as the swing producer of oil.
 
Once upon a time a threat to Saudi production would be a dagger aimed at global economic growth, but perhaps not any more.
 
You may recall the oil price crash of 2016 I mentioned earlier was caused by Saudi Arabia and its OPEC allies flooding the market with oil to try to crush the emerging fracking industry that was enabling the US to regain dominance in the energy market.
 
Well, that tactic didn’t work. The US is extracting more oil and natural gas than ever, and there are thousands more wells ready to go into production and become economically viable, if and when they’re required .
 
Indeed, far from the shortage of oil that many of us grew up hearing was just around the corner, it seems closer to the truth to say the world is awash with the stuff.
 
However that brings me to the second big story of the month.
 
Across the country – and the world – millions of children have resumed their strikes to call for more action to tackle what the UK now officially terms a ‘climate emergency’.

The continued burning of fossil fuels and (third news story alert!) deforestation in places like Brazil and Indonesia, means we’re emitting near-record amounts of CO2, despite the science being pretty much unanimous that this is a bad idea.
 
The UN for example says climate action must be increased fivefold to limit warming to 1.5C above pre-industrial levels. From where I’m standing it seems more likely we’re headed above 2C, and probably in most of our lifetimes.
 
I won’t go down that rabbit hole. Suffice to say there’s clearly a tension here – abundant fossil fuels at pretty low prices, and yet a need to stop burning the stuff pronto.

Make your mind up  

So to repeat my initial question, is there a trickier sector to assess than energy?
 
On the one hand, advances in technology have upended the status quo of the past 50 years, bringing ever more oil out of the earth’s crust at affordable prices – though not at prices as high as old-school titans like the FTSE majors would prefer.
 
Yet on the other hand, scientists urge us to leave as much of it there as we can.
 
Overlay those massive countervailing forces with more humdrum stuff like the potential for a demand-sapping trade war and the coming of electric cars, and I’m not surprised investors want a better-than 6% yield for being not-quite-so-sure of Shell.
 
If you think differently, you needn’t write an angry email to my editors – something articles about global warming and Not So Peak Oil are prone to prompt, for some reason.
 
Simply buy the shares of BP and its brethren, and collect your big dividends.
 
If oil isn’t going to stay relatively cheap forever – indeed if we can burn it all without incinerating ourselves – then the shares of the majors must be a bargain.

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Owain Bennallack has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.