beyondbrics

By Rob Minto and Stefan Wagstyl

This week has seen the oil price hit new highs in euros and sterling, with worries over Iran prompting bullish calls of $150 a barrel.

So oil is on the up. And emerging markets have oil – and lots of it. But does buying emerging markets oil and gas stocks give a better return than simply investing in Brent crude, or investing in the energy majors?

Chart of the week investigates.

Below you can see Brent crude compared to two oil majors, Royal Dutch Shell and Exxon Mobil, and the Dow Jones EM oil and gas index, from the start of 2010.

There is a rally in oil from July 2010 onwards, with two big surges in the start of 2011 and 2012.

There is a correlation between the oil price and the share price of the two majors. But Brent has risen over the period by 59 per cent, outpacing the company shares which have risen by less than 40 per cent. However, the fluctuations in price between the price of Brent and the shareprice is roughly in step.

Now compare the Dow Jones Emerging Markets Oil and Gas Titans 30, to use its full name, from the start of 2010 – the blue line in the chart. For much of 2010 the index is doing better than investing in Brent, but something happens around the end of 2010, and again around March-April 2011. In both periods the EM oil and gas index misses out on the rally in oil. And again, the 2012 rally is largely absent for the EM index.

In fact, over the period, the EM oil index rises only 22 per cent.

There are good reasons for this. As oil prices rise, governments often take a higher share of the oil revenue in taxes. In Russia, for example, oil producers have repeatedly complained that high tax rates inhibit investment – and what inhibits investment can inhibit investor returns.

On top of this, most of the largest EM-based oil and gas producers are state-controlled, including the leading Chinese and Indian energy groups, Rosneft and Gazprom in Russia, and Petrobras in Brazil. Others are subject to government influence, for example with tight price and tax regulations.

As a result, companies cannot prioritise shareholder returns to the degree achieved by western majors.

Such control and influence in the energy sector is hardly unique to EMs. But they are often applied in EMs in less transparent ways than in the developed world, making investors wary.

As well as these general factors, company-specific issues are at play. China’s Suntech Power, the worst performing company in the index, is an anomaly – its business is solar panels and it has suffered in the general gloom that has settled over the industry’s profitability.

Shares in Petrobras, the Brazilian state-controlled group second from bottom in our table, have been hit by investor concerns about government interference, a big capital-raising that diluted shareholders, and the company’s capacity to manage its vast programme to develop undersea pre-salt deposits.

Reliance Industries, placed just above Petrobras, has seen its share price fall over worries about diversification plans, weak margins and arguments between the company and regulators and between Mukesh Ambani, the billionaire dominant shareholder, and his twin brother Anil Ambani, head of a rival business group.

Altogether, there is only one company in the index that has out-performed Brent crude over Jan 2010-Feb 2012 and that is Novatek, the Russian gas group, which has risen over 106 per cent.

As with the extreme underperformers, special factors are at play. Industry watchers say Novatek owes some of its success to backing from Gennady Timchenko, the Russian billionaire businessman and friend of prime minister Vladimir Putin, who bought about 20 per cent of the company in 2009. Putin denies having given his friend a leg up in business.

Novatek last year forged a strategic partnership with Total, the French oil major, to tackle Russia’s flagship Arctic liquefied natural gas development. The bigger its position in the Russian energy sector, the better for investors.

But Novatek is the exception. For investors in all other EM energy companies in the index, making money from higher oil prices proved harder than making it from crude itself.

Six members of the index were included after January 2010, so are not included in the table above.

Related reading:
Chart of the week: oil dependency, beyondbrics
FT Oil and Gas section