Over the decades I’ve been investing in shares, oil stocks have regularly come into and gone out of favour.
Quick profits
For many, the excitement of a new oil explorer and the massive profits that can sometimes come from a major new oil find are what attract them, in the hope of getting rich quick.
But oil exploration is very risky, and usually requires taking on very large debt, which is backed by potential hydrocarbon assets. That can put companies at the mercy of the oil price and, if it falls, then their debts might not be adequately covered — and the sound of banking covenants breaking is not what investors like to hear.
It’s not just the tiny oilies on the Alternative Investment Market (AIM) facing big risk. No, FTSE 250 constituent Premier Oil, with a market-cap of £600m, and even Tullow Oil, valued at £3.1bn, came close to the edge during the oil price slump.
Oil future
If you’re convinced that there’s still a long and cash-rich future ahead of the oil business (which there surely is — weaning the planet off fossil fuels is a noble aim, but I don’t see it happening in the next few decades), how can you invest in oil safely?
The obvious answer, to me, is to go for one of our big FTSE 100 oil companies, like BP (LSE: BP).
I’m not saying the oil price crunch didn’t bother BP, as it clearly did, with profits taking a significant hit. But BP had (and still has) enormous assets, and was easily able to offload some riskier and non-core assets to raise the cash to keep it comfortably afloat.
Chief executive Bob Dudley reassured investors right at the beginning of the oil price slump, saying he fully expected the downturn to last for a few years and that BP was committed to paying its annual dividend. The company did exactly that, even through several years in which the annual payment was not covered by earnings.
Safe dividend
Today, we’re looking at forecasts for strongly recovering earnings, dividend cover growing, and BP’s dividends set to yield around 6% per year. And speaking of BP’s dividend reliability, even during the Gulf of Mexico disaster, the dividend was only hit for a couple of years before resuming at a healthy level. That, for me, is what makes BP a strong ISA candidate.
We’re coming up to a new ISA allowance in April, and we’re sure to see all the banks and other investment firms advertising their cash ISAs. And who knows what short-term offers they’ll make? But introductory rates don’t last long, and you’ll struggle to find long-term rates of much more than 1% per year these days — and that’s with inflation running at about 2%, so they’re guaranteed losers.
Beating cash
But 6% per year from BP shares in a stocks and shares ISA is a very different proposition, and I think a very attractive one. I think the share price is very likely to rise in the coming decades too, but you can think of that as a bonus on top of your 6% per year income.
Put together a handful of other FTSE 100 dividend payers from different sectors, and I think you’ll have the making of a profitable long-term ISA.