Why this veteran fund manager is bullish on oil

Paul Mumford, manager of the Cavendish Opportunities fund, is betting on the general direction of the oil price going higher and has lined up a suite of shares that he thinks are poised to soar.

Mumford, who targets growth and recovery stocks, believes oil prices will eventually recover from their deep downturn.

He predicts that, over the medium term, the oil price will gently rise higher, arguing that it is in the best interests of oil producers to cut production. After all, he says, a higher oil price and lower supply of oil will generate more profits.

Mumford predicts some heavily beaten-down shares are potential "10-baggers", or in other words could increase in value tenfold.

Small-cap players

He is focusing his sights on the small-cap segment of the market, highlighting Cairn Energy, Tullow Oil and Faroe Petroleum as three names that could soar in the coming years.

These small-cap names have sold off heavily over the past three years. Tullow Oil, for example, is down 65% since December 2013.

"The strongest survivors of the downturn have got themselves into healthy positions by reducing costs, particularly drilling costs; that has been one of the main benefits of the oil price falling," says Mumford.

Mumford's 'right price' for oil is around $60 a barrel and he does not expect a slide back to $30"Some of the stocks I own have net cash on their balance sheets, so can pay down their borrowings."

Part of the nature of investing in oil is that specular booms and busts come and go. But Mumford is confident that the latest collapse, which started in June 2014 when oil was trading at over $110 a barrel and saw it fall to below $30 earlier this year, has come to an end.

At the time of writing, the oil price was hovering just above the $50 mark, enjoying a rise of 10% yesterday, following an agreement by members of the Organisation of the Petroleum Exporting Countries (OPEC) to put its first limit on oil output since 2008.

Mumford adds that the low oil price is a supply rather than a demand problem, making the point that "unlike some of the other commodities, oil does get used". The manager predicts the right price for oil is currently around $60 a barrel and does not expect a slump back down towards $30.

Mumford, however, is more cautious on the outlook for the lager cap oil stocks, including BP and Royal Dutch Shell.

Those in the bear camp say oil's longer term outlook is poor thanks to alternative energy sourcesHe says that while the high yields on offer are eye-catching, both oil majors need to replenish their reserves after cutting exploration budgets following the oil price fall.

To dig themselves out of a hole, the major oil producers may have to buy smaller companies as a means of acquiring assets.

"It is in everyone's interest for the oil price to go up, particularly Russia's," adds Mumford.

But, he cautions, fishing in this area is not for the faint-hearted, which is why he owns a wide spread of stocks, with oil and gas accounting for around 15% of the portfolio. "Some will inevitably go belly up," he warns.

Those, however, in the bearish camp point out that the longer term outlook for oil is far from rosy, due to the rise of alternative energy sources, including shale gas.

Other investors are concerned about the dividend cover of the two oil majors - Royal Dutch Shell and BP - so are therefore steering clear.

Paul Mumford recently shared some of his stockpicking wisdom and top tips for 2017 in video interviews with Interactive Investor. Click here to view them on our videos page.

This article was originally published in our sister magazine Money Observer. Click here to subscribe.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.