The Investment Column: Oil Securities lacks a dividend, making it a risky punt on crude

Click to follow
The Independent Online

This is the stark new prediction yesterday from Goldman Sachs, the investment bank which is cementing its reputation as the arch-bull of the oil price. Only in the spring, Goldman was telling the world to brace for a era of "super-spikes" that would send the cost of a barrel periodically over $100 - the level, adjusted for inflation, which triggered the global recession of the Seventies.

Yesterday the bank was predicting the oil price will reach "a new equilibrium" around $60 a barrel, some $15 above its previous prediction. Why so bullish?

Much of the City's analysis on the likely direction of the oil price is concerned with supply and demand. It asks, how much oil is coming out the ground and going through the world's stretched refineries, versus how much is likely to be consumed by the developed and industrialising world.

Investors and analysts who believe the oil price could be headed sharply downwards soon point to growing stockpiles in the US, suggesting the demand is growing less strongly than supply at the moment.

But Goldman asks not whether there are sufficient supplies to meet demand, but how much it will cost to supply the market with oil from conventional or new sources. And the answer to that is: significantly more than it does at present.

As you can see from the graphic, the cost of the most expensive major oil projects has soared. And the cheap projects, where large quantities of easy-to-get oil were found long ago, are no longer gushing, and more expensive, complex extraction techniques are needed to get the last oil out.

The need for new discoveries is growing, but the cost of exploration is difficult to guage because success is not guaranteed, and there are political uncertainties in most of the new areas being explored. Faced with this swarm of imponderables, the major oil companies are sitting on their cash or giving it back to shareholders rather than investing it for an uncertain return. That makes the shortage of new projects even more acute.

Goldman argues that future costs will become easier to judge as companies' experience of the new era grows. But the cost of operating in new, remote locations - including the cost of tempting skilled workers to move to these remote areas - will be high, hence $60 oil is here to stay.

UK punters who want a bet on the oil price have a new instrument at their disposal. Rather than having to speculate indirectly by buying or selling BP and Shell shares, or - impractically - actually buying or barrels of oil - investors can buy Oil Securities.

These are securities traded on the stock market which track exactly the price of oil. They are traded in US dollars. The first is based on Brent crude, as priced by the International Petroleum Exchange, although others will follow.

They could be a fun punt from time to time, particularly if you believe Goldman's "super spikes" theory that the price could be squeezed dramatically high by episodes of weather- or terrorist-related disruption to oil supplies.

But with no dividend or interest on Oil Securities, even if the arch-bull is right about the long-term equilibrium of $60, they look no great investment at last night's $61.57.

Bull semen business is booming so it's natural to hold on to Genus

It is Darwinism in the raw. Every year, 400 new bulls are auditioned by Genus, the animal breeding specialist, but only the most virile and impressive of stature go on to father a new generation for the company and to have their semen sold to farmers around the world.

Not quite in the raw, actually, since Genus's unique skill lies in the way it uses genetic screening techniques for its unnatural selection. Profits from semen sales and the company's other activities are expected to top £12m this year.

At the company's annual shareholder meeting yesterday, the chairman, John Hawkins, said that the company continues to trade well, although changes to the European Union's regime of subsidies for farmers are creating uncertainty.

Genus has been beefing up its cattle markets business in Victoria, Australia (a state that Mr Hawkins describes as "cow-dense"), with two small acquisitions. These are being used as a way of learning about the local market and ought to help Genus grow in this important farming country.

Genus has doubled its annual profitability in five years and its shares have performed in line with that. We tipped them in November last year, since when they have risen 27 per cent. At 337.5p, down 4p yesterday, they are valued at 14 times current year earnings and have a dividend yield of 2.5 per cent. Hold.

Chaucer could yet write a takeover tale

Chaucer, the Lloyd's of London underwriter, has been at the centre of a wave of unsuccessful merger and acquisition activity in the insurance sector over the past year - playing the role of both consolidator and target in two sets of talks that eventually came to nothing.

Chaucer is well-cast in either part. As acquirer, there remains a handful of good and, as yet, unexploited opportunities - even after the company's failed bid for Highway in the spring.

As a target, Chaucer is also attractive. As its latest trading update revealed yesterday, it is continuing to write a good volume of business at strong prices, despite a market where premiums have been falling pretty sharply. Like all Lloyd's insurers, it is unlikely to ride out the cycle completely unscathed, but good management and disciplined underwriting appear to have put the company in good shape.

Although a buyout of the company would obviously be the best short-term result for shareholders, a well thought through acquisition could also serve investors' interests over the longer run.

With a dividend yield in excess of 4.5 per cent, and the shares trading at just 6.3 times this year's predicted earnings, Chaucer is the best of the bunch for new investors looking for exposure to the Lloyd's sector at this risky time in the insurance cycle.

Buy to tuck away.