How to cash in on the rising price of energy

It's not just utilities firms who can profit from climbing oil and gas costs, reports Gary Shepherd

A shale fracking drill platform in Lancashire (Getty Images)

Like the annual rail fare hikes, rising energy costs are an inevitable part of winter living. But there are ways for canny savers to benefit from climbing oil and gas prices, so long as they are willing to accept some level of risk.

More than one in five people spend at least 30 per cent of their income on heating and lighting their homes, and prices are set to rise further.

But why are energy prices on such an upward curve?

Angelos Damaskos, chief executive of the commodities specialist Sector Investment Managers, believes that utility companies have been exercising their market power to improve their margins. "The UK is dependent on gas for residential as well as industrial uses and gas supplies are constrained by existing pipeline and storage capacities," he says. "As oil prices rise, so do the gas prices, and the utilities companies pass on the cost to the consumers. Unfortunately, on the back of rising input costs, retail prices seem to rise more than the commodity."

Brent crude oil regularly trades above $100 per barrel, and analysts predict that this will remain the case throughout this year owing to threatened supply.

This is despite the so-called "shale revolution" where an acceleration of fracking of natural gas in the US could make it energy independent within the next 10 years.

So is it worth putting a small percentage of your investment portfolio to work in these markets?

For Ben Seager-Scott, a senior research analyst at Bestinvest, investing in oil and gas can be challenging. "Generally, investors can take indirect exposure by investing in the equity of companies involved in the oil and gas industry, or more directly through derivatives that are based on the oil and gas prices – for example, Exchange Traded Commodities (ETCs)," he says.

"When taking indirect exposure, I would suggest that clients look to invest through funds rather than individual equities, to ensure they have diversification in their portfolio. This way, as well as the well-known oil majors, such as Exxon Mobil, Shell and Total, investors may also profit from smaller companies which benefit indirectly from energy production through the provision of specialist products and services, such as laying underwater pipes or building specialised drilling equipment."

Mr Seager-Scott prefers Investec Global Energy and Artemis Global Energy funds. The latter is considered a rather more aggressive vehicle as it has greater exposure to a number of riskier, smaller companies.

Tom Nelson, an energy-investment specialist at Investec Asset Management, believes energy prices will be driven up this year by increased spending on drilling and services because of difficulties in growing oil production. "With 50 per cent of major discoveries since 2005 in deep water and a growing reliance on unconventional oil in the US and elsewhere, oil service technology and complexity will be more important than ever," he explains.

However, this increases the risk of accidents, as we saw with the Macondo blowout in the Gulf of Mexico in 2010, which caused unparalleled damage to the environment and, of course, BP's share price.

Christopher Wheaton, an energy analyst at Allianz Global Investors, stresses that these events remain incredibly rare, and a disaster on the scale of this is unlikely to happen again. "We think the risks of investing in energy from a big-picture economic perspective are actually low given the strength of oil demand," he says. "And if anyone thinks that the big growth in US shale oil production will drive oil prices down significantly, they are wrong – the US has laws forbidding export of the oil they are producing, so it will stay in the US."

Heralded as an aid to economic recovery in the US, could we in the UK also benefit from technological advancements in fracking? In simple terms, this is the process of drilling and injecting fluid into the ground at a high pressure in order to fracture shale rocks, thereby releasing the natural gas inside.

Just last month, engineers were given the go-ahead to resume testing in Lancashire after initial drills were suspended, having caused minor earthquakes near Blackpool.

"The commercial viability of UK shale gas is still some way from being proven, and a more dense population adds additional complexities," said Adrian Lowcock, senior investment manager at Hargreaves Lansdown.

"Whilst the introduction of a new source of energy maybe good for the UK economy, it is less clear whether it would be good for investors."

Despite the global nature of the energy sector, Mr Lowcock suggests investing in a generalist UK equity fund, such as M&G Recovery, which will have some exposure to FTSE-listed oil and gas majors and explorers, rather than through a specialist vehicle or ETC.

For those wanting exposure to some of the more risky assets then he suggests the Sector Investment Managers-led Junior Oils Trust; however, investors can expect a rocky ride.

"Avoid ETCs unless you are an experienced oil and gas professional or commodities fund manager as these require detailed understanding of the market," he warns. "For a diversified approach, First State Global Resources provides exposure to oil and gas shares along with other commodities and mining companies."

Looking further afield, several of the world's giant developing economies, such as Russia and Brazil, have benefited from their vast natural resources as well as housing some of the largest and most profitable businesses in the energy sector. So could investors get adequate exposure to oil and gas this way?

Tim Cockerill, head of collectives research at Rowan Dartington, sees Bric (Brazil, Russia, India and China) funds as an indirect way of gaining exposure to commodities with access to the fastest-growing economies in the world.

However, he still advocates investment in the oil and gas sector via a dedicated fund, provided it is a modest part of a larger portfolio.

"Holding oil and gas ETCs does, in my view, constitute a higher-risk approach and should be approached with caution," he says.

Two of the more popular indices which ETCs might track, the S&P GSCI Natural Gas Spot and S&P GSCI Brent Crude Spot, delivered broadly similar returns over the course of 2012 – an investment in the gas index would have delivered 3 per cent, with the oil measure being essentially flat.

However, this does not take into account wild fluctuations that happened throughout the year.

For example, an investment in gas in January 2012 would have fallen in value 35 per cent by the middle of April, though if you had held on, your initial investment would have climbed in value 31 per cent by the middle of November, according to data from FE Analytics.

Over three years, the Brent Crude Spot delivered 40 per cent returns, while the Natural Gas Spot was down 42 per cent.

By contrast, Investec Global Energy delivered an essentially flat performance over the same period.

It is important to note that dedicated energy funds have not exactly set the world alight with stellar performances over the past three years. Nevertheless, on a longer-term basis they have delivered – since launch in November 2004, the Investec fund is up more than 125 per cent, while Junior Oils Trust has risen by around 60 per cent since its conception in the same year.

Their performance during the coming years will depend much on macroeconomic factors.

"Risks are numerous but all really centre around one thing: supply and demand," adds Mr Cockerill. "Political events in the Middle East, the decisions made by Opec, expectations for shale gas and oil production and global economic growth are all factors that will impact supply and demand and the oil and gas price.

"Of the two, oil is the most sensitive," he says. "However, most of these impacts are likely to be shortlived and investors should be looking long term at the steady growth in demand for energy globally.

"Shale gas and oil production in the US will have a longer-term impact and may enable them to be much more self-sufficient in the future, but global demand is going to keep on rising."

Whatever your views on the oil and gas sector, one look at related companies listed on the FTSE 100 tells us that its prospects have a large impact on our portfolios wherever we choose to invest our savings.

Royal Dutch Shell, BP and BG Group are all in the top-10 largest listed companies in terms of market capitalisation, and their reign is unlikely to end any time soon.