It has been a roller-coaster year for the price of oil, but with signs that the worst is behind the commodity, some investors will be wondering if now is the time to pile in.
From its low point of less than $30 a barrel earlier this year, the price has recovered to around $50, still well below recent highs of more than $100.
As the price fell, oil companies were forced to make efficiency gains, downsize and diversify to keep their heads above water.
The reasons behind the price drop were no secret: US shale oil production grew markedly amid slowing demand from Europe and China, particularly as the latter is shifting from an industry-led to a consumer-driven economy.
An Opec price war fuelled the fire, as exporters chose to defend market share rather than maintain the price of oil. The recovery has been caused by a series of production problems, but those appear to have come to an end, leading the price to stall.
As the oil price is so unpredictable, deciding whether there is an investment case is no straightforward task. There are proponents on both sides, although the decision ultimately depends on the understanding and needs of the individual investor.
Stephen Bailey, co-manager of the Liontrust Macro Equity Income fund, recently announced that his fund was selling out of oil entirely, making use of the strength of the dollar to sell holdings at full valuations.
Mr Bailey explained that certainty of income, dividend sustainability and growth from elsewhere in the market were all preferable to “the allure of high yields” – currently Shell and BP yield more than 7pc.
He said: “With oil trading at less than $50, the oil and gas sector fails this test. It varies between companies, but broadly the oil majors require an oil price of $50‑$60 to maintain current dividends and commitments.
“Below this level, cash flow is insufficient to support, let alone progress, dividends, and alternative sources of funding are required.”
He also said the longer-term cost of weaker oil prices had not been considered and the sector’s outlook was being clouded by the growth of alternative energy sources.
“Even the Saudis appear to know the fossil fuels game is up,” said Mr Bailey.
The main question that investors need to ask is whether the changes made by the large oil producers in response to the price crash are enough to make them an attractive long-term bet.
Philip Haworth, an investment manager at Kames Capital, the fund group, said: “The changes are not just skin deep. Companies are undertaking a serious re-engineering of their business practices.”
Despite that, however, he doubted that their model would work with oil in the $40 range, pointing out that major European oil firms had missed profit estimates and failed to generate free cash flow in the second quarter of this year.
He said: “This leaves investment in the sector as rather a long-term judgment call. The companies cannot keep increasing debt to pay dividends forever, but yields of around 7pc on Shell and BP mean an investor is at least being paid to wait for better times.
“If the companies deliver on their efficiencies and the oil price rises, there is a path to growth. But that’s a big ‘if’ and one suspects there are more dependable investments available within the stock market.”
How an investor gains exposure also matters a great deal, as the divergence in risk between the different options is substantial.
Attempting to gain exposure to the commodity directly through an exchange-traded fund (ETF) is essentially a bet on the oil price.
The ETFs on offer can also be very complex, as some involve “shorting” – betting the oil price will go down. Experts have warned that these funds are not suitable holdings for the long term – which means more than a day in some cases – so they have little place in the average investor’s portfolio.
If you are interested in using an ETF to gain exposure to the oil price, you can read more here.
Viktor Nossek, director of research at asset manager WisdomTree Europe, said: “Unless you have a strong view on the commodity itself, the oil price is so volatile, and more often than not affected by speculative positioning, that gauging the fair value of crude oil becomes an impossible exercise that is likely to damage returns.”
However, Mr Nossek was more positive about the efforts that oil companies had made in response to the price crash.
“This will help them cut costs and stabilise revenues and we would expect this to feed through into results from now on. The low oil price has also made them focus on their most profitable oilfields, and when prices recover these assets will be particularly attractive,” he said.
Buying shares in major oil and energy businesses is certainly less risky than buying direct exposure to the price of oil, but these shares will need to be held within a diversified portfolio.
Another option to rein in risk further is to buy a commodity or energy fund that invests in companies from around the world and across the sector. The performance of these funds won’t move exactly in line with the oil price, but will be influenced by it.
Darius McDermott, the managing director of Chelsea Financial Services, a fund shop, recommended Guinness Global Energy as one option to consider.
The fund holds oil and gas producers, oil equipment companies and alternative energy companies, although 86pc of holdings fall into the first category. A fund such as this would again need to be held as part of a well-diversified portfolio.
Mr McDermott added: “Despite massive dips, global energy equities are up by 220pc in sterling terms over the past 20 years. Global equities overall have managed 167pc. So there is definitely an argument to make for a temporary dip in prices providing a buying opportunity.
“Nothing ever goes up in a straight line, but I’m still happy parking some of my savings in the sector.”
He cautioned, however, that “a glut of petroleum” was making markets nervous, with falling margins, and that “it’s difficult to see what might help refineries to clear out their stock in the short term”.
Shell, Exxon, BP and Chevron all posted substantial profit falls in their half-year results, and questions remain around dividend sustainability.
Ultimately, oil, gas and energy are not areas to be entered into lightly at present. For investors who do not have a particular enthusiasm for the sector, there are less nerve-racking options to consider, with more straightforward cases for investment.