Rising oil prices have been a dominant investment theme in the past two years, and how to play this trend is a challenge for anyone running a portfolio. Generally, I have had fairly little exposure to oil companies over the years. But once I noticed that crude oil prices were climbing significantly at the start of 2004, I started to pay some attention and began my research.

In hindsight, perhaps at this stage I should have bought an oil explorer. Instead the first company that grabbed my attention was Royal Dutch Shell, which was just becoming entangled in its reserves overbooking crisis. While the overbooking issue was a significant failure of management, it clearly wouldn’t affect the actual amount of oil that the company would ultimately possess, merely its reasonable valuation.

As the news of management backbiting continued, it seemed increasingly possible that it could lead to the final break-up of the awkward Anglo-Dutch structure which had held the company back for so many years. Fundamental attractions were there too. The stock traded at a 2 percentage point forward price/earnings discount to BP and its dividend yield was over 4.5 per cent.

Picking your contrarian moment is tricky in such circumstances, and I was perhaps a little tardy, buying in July 2004 at the equivalent of 1359p. Still, this allowed me to ride two good news stories at the same time. One was the fact that Shell was in the process of being transformed into a leaner company, and the second that, however many barrels of oil it did possess, each was worth significantly more than it was a year earlier.

When the company restructured, most of the good news was in the price. Having bought on the rumour, I sold on the fact, getting 1800p in July 2005, a 36.5 per cent profit, including dividends.

My next buy was the US oil and gas producer Apache. It has substantial producing assets in Egypt and Australia, owns a big stake in the mature North Sea Forties field and increased its proven reserves by 17 per cent last year. Its large holdings of natural gas were particularly attractive, especially as the company traded at only 9.7 times forecast earnings when I bought it for $49 a share in November 2004. It now stands a shade under $70.

Oil prices peaked soon after Hurricane Katrina this summer, and signalled a new phase for working the oil issue. It soon became clear that prices were unlikely to move higher in the short term, and conventional oil companies and explorers would be at the mercy of oscillations in the price of crude. While that may work as a hedge for the rest of the portfolio, it wouldn’t allow for much upside. Instead, I started to look for companies that would benefit whether oil was $35 per barrel or $65. I found two.

One was Britain’s Abbot Group, which makes and supplies drilling rigs. It was quite apparent that exploration activity has become frenetic since the oil price rise, and companies that supply the equipment and know-how are well placed to benefit. I bought at 258p at the end of August. Interim results released in September were, as expected, unspectacular but the chairman said he saw “a very strong outlook for accelerated growth”. So far the shares have remained fairly flat, but as more evidence of increased activity trickles through, I am expecting some uplift.

Finally, I was drawn to those dirty, smelly and ugly plants called oil refineries. Because of planning difficulties and weak oil prices in the past, there hasn’t been a refinery built in the US for three decades. Indeed, the current oil crisis has been caused more by a shortage of refining capacity than by a shortage of crude oil. Though there is plenty of crude around, much of it is “sour” crude which needs extensive refining.

While oil majors own refineries, this is only part of their activities. I wanted a pure play, and found one in the US – Valero. By quietly buying up and modernising ageing US refineries, Valero has built itself an unassailable niche. The lead-time on planning and building any new refineries gives the company several years to squeeze the shortage for all it’s worth.

My timing, however, was anything but refined. I bought at $115 on October 3, just days before huge profit-taking swept across oil stocks. Now, at $102, I’ll have to wait for the market to remember that this company, which makes its money on the spread between crude oil and retail gasoline prices, is a little different from conventional oil companies.

Nick Louth is an active private investor, writing about his own investments. He may have a financial interest in any of companies, securities and trading strategies mentioned.

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