Oil price rally: are there opportunities in ‘cheap’ energy shares?

Energy is one of the largest sectors on the UK market, representing over 13% of the FTSE 100.  If you’re thinking about getting a little exposure, it’s important to understand the reasons behind rocketing oil prices – and the surprising longevity of oil.

What is happening to oil prices?

Avid watchers of the markets will be aware that oil prices have been on a tear in recent months after Saudi Arabia and Russia announced steep cuts to production in early June.  This was in addition to a broader move by the OPEC+ cartel of oil producers aimed at reducing supply through to the end of next year, which represent the largest production cut outside of a recession in two decades.

These measures also come at a time when US strategic oil reserves have been drained to less than half their capacity and the Biden administration is resolutely focused on Net Zero.

In the face of such a significant supply shock, it is no wonder then that oil prices recently hit a ten-month high. Since the start of June, Brent Crude has rocketed from $74 a barrel to over $93 at the time of writing.¹

How does the price of oil affect the stock market?

From an investment perspective, it is worth noting that there has been a quite significant de-coupling between oil prices and the performance of energy company shares during the supply shock driven rally.

As you can see from the chart below, the correlation between crude prices and energy shares has broken down recently. While crude prices have risen c.28% since 1 June, energy shares – represented by the MSCI World Energy Index – have returned c.15% (including dividends).

Good to know: past performance is not a guide to future performance. 

Either equity markets are being rather sanguine and assume the oil price spike is a temporary blip, or there could be an opportunity here?

One thing is for sure: energy shares are cheap, with energy equities globally trading on price/earnings multiple of just 7.2 times their earnings forecast for 2024, well below global equities overall which are trading at 17.4 times forecast earnings.²

What will happen to the price of oil in the future?

Intuitively, it may seem unwise to invest in companies whose main product is set to be phased out over time. But as we were reminded of in recent days with the Prime Minister’s decision to push out the date when the sale of new combustion engine vehicles will be banned in the UK, refined oil is set to remain in demand for many years yet.

In fact, since the 2015 Paris Agreement, when countries across the world made legally binding agreements to tackle global warming, energy companies are a lot more disciplined about capital expenditure and  have a much greater focus on sweating the profitability of their existing operations.

If oil prices do stay at elevated levels for some time and energy companies remain disciplined about capital expenditure, this will support profitability. Other factors that may prove supportive to the outlook for energy shares include:

• Global inventories of oil at historic lows
• Fading fears over a US recession and
• A scenario of global interest rates remaining higher for longer constraining investment in new sources of supply  

For the UK-listed oil giants, the resurgent strength of the US Dollar should help earnings that are reported in Sterling as oil is priced in Dollars.

How we can help you understand more about energy shares

If you’re keen to understand more about different ways investment portfolios can be exposed to oil, you can book a free coaching session with one of our financial planners. Get an expert’s perspective on your plans so you can decide what’s right for you. It’s easy to book yourself in and there’s no ongoing commitment.

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Source

¹ Oilprice.com

² IBES, MSCI, Datastream as at COB 21 September 2023

 

Important information

This article does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication.

Funds that invest in specific sectors may carry more risk than those spread across a number of different sectors. In particular, gold, technology and other focused funds can suffer as the underlying stocks can be more volatile and less liquid.  

Past performance is not a guide to future performance.

Source: MSCI. Neither MSCI nor any other party involved in or related to compiling, computing or creating the MSCI data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of such data. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating the data have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. No further distribution or dissemination of the MSCI data is permitted without MSCI's express written consent.