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Five ways to play the oil price rally

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News of the first cut in oil production for eight years this morning led the price of Brent crude, the international benchmark for oil, to jump almost 6% to $49 a barrel of oil. Here are five ways you could participate in this rally.

A fourth straight drop in US oil inventories and the announcement that OPEC’s Algerian summit could lead to production cuts are both boosting oil prices this morning, to the benefit of not just drillers and equipment suppliers but potentially the whole FTSE 100.

In some ways the higher the oil price goes the better it is for the FTSE 100, at least in terms of earnings and particularly dividends. This means there are several ways in which investors could address a sustained advance in oil prices.  In order, from least risky to highest, investors have plenty of choice. The more risk that is taken the greater potential reward if oil keeps rising but equally the potential downside would be greater should the rally fizzle out.

1. UK equity tracker fund

BlackRock UK 100 Equity tracker is an Oeic and comes with an ongoing charge fee (OCF) of just 0.06%. BP and Shell both feature in its list of top five holdings with a combined weighting of around 7.5%. The SPDR FTSE All-Share ETF performs the same function and also has top-five weightings in BP and Shell.

2. Actively managed UK equity fund

According to oilprofit.de, a lot of the top performers in the UK Equity Income category have low weightings in the oils so they have a big decision to take, as to whether to jump back in or not. One fund which already has top-five positions in both BP and Shell is Schroder UK Alpha Income, run by fund manager Matt Hudson.

3. Energy-themed fund

One option to consider here is the ETFS US Energy Infrastructure ETF (exchange traded fund). Listed on the London Stock Exchange, this tracker follows a basket of 24 American energy pipeline, storage and logistics firms, a lot of whose share prices have fallen hard alongside the actual oil price. The tracker offers a dividend yield above 6% and could rally if oil makes sustained gains.

4. Oil tracker

Investors may want to avoid stock specific risk and just follow the oil price. ETFS Crude Oil ETC tracks the US benchmark, West Texas Intermediate, and ETFS Brent Crude the equivalent European oil benchmark. Note that both trackers follow a basket of oil futures prices, not the spot price, and both use synthetic replication (derivatives) to achieve this. Besides movements in the oil futures, investors are also exposed to the roll yield and collateral yield for their total return on investment.

5. Oil stocks

BP and Shell have both been hit hard by the slump in oil so it would be reasonable to expect their share prices to respond positively if oil does forge a sustained price recovery, not least as this would give greater comfort on their plump-looking dividend yields, which are in the 7-8% region.

Less well developed, pure play producers like FTSE 250 firms Cairn and Tullow could also benefit, but the operational and exploration risks are higher here, and then the riskiest oil plays are the AIM-quoted junior explorers which may not even be producing or have a find, but whose share prices could welcome more positive sentiment toward their industry.

Fixed-income investors will doubtless be watching the bonds issued on the London Stock Exchange’s ORB platform with interest. Issued with a 5% coupon the 2020 Premier Oil bond offers a yield to maturity of 11.8% and the EnQuest 5.5% 2022 paper offers 21.2% as both trade well below par, owing to fears about how a long run of low oil prices could leave their balance sheets looking very stretched.

If oil makes great gains and holds on to them this could ease the pressure on both firms, boosting the price of their shares and their bonds but the very high coupons involved make it clear that the risks are very high and neither is suitable for widows or orphans.

Russ Mould is investment director at AJ Bell