How does the rising cost of oil affect your mortgage or investments?

Growing economic demand and threats to supply have turned oil into black gold, pushing prices to record levels. The price of crude oil rose more than 30 per cent to almost $US50 ($72) a barrel in the six weeks to mid-August before settling back to $US42 early last week. However, the terrorist bombing in Jakarta pushed the oil price back to $US44 a barrel by week's end.

If the oil price remains above $US40 a barrel, the effects will spill into the sharemarket, creating risks and opportunities for investors.

Rising oil prices put pressure on consumers at the petrol pump and dent consumer confidence, but they also filter through the economy to the prices of other goods and services, eventually forcing manufacturers and oil-dependent industries to raise prices or cut back production. Hence rising oil prices fuel inflation and increase the likelihood of a rise in interest rates.

There is a lot of debate on financial markets about whether oil prices will fall back below $US40 a barrel or continue to rise. This uncertainty may fuel sharemarket volatility.

Stephen Bartrop, of Fat Prophets Mining, believes prices have been boosted by speculators and will moderate and fall below $US40. However, his colleague Jason McIntosh, at Fat Prophets, believes the bull market in oil prices is here to stay. He says prices could have further to go as demand grows and supply is pushed close to capacity.

Cavil Singh, the head of broking services at Godfrey Pembroke, points out that the real price of oil is still below 1982 levels and believes higher prices are here to stay because of the huge demand from industrialising countries such as China and India.

Rising interest rates and oil prices are expected to slow down corporate earnings growth locally and in the US, but, Singh points out, last year's growth in earnings of 22 per cent and 30 per cent respectively was at a decade high.

Forecast earnings growth this financial year are about 10-15 per cent for Australian companies and 20-25 per cent for US ones.

McIntosh says the energy sector will reap the benefits of higher oil prices and increased local production in coming years but also likes the resources sector generally.

Bartrop says that although oil and gas producers are making windfall profits and have enjoyed a good sharemarket run, share prices have been capped due to market cynicism about the sustainability of stronger oil prices. He believes it would take some sort of shock, such as a major terrorist attack, to push share prices higher.

Bartop advises investors to look to the producing end of the energy sector and wait for any artificial weakening of share prices for opportunities. For example, he says, Santos looks attractive after a poor profit result on the back of the Moomba gas plant fire depressed the share price. He argues that the production profile going forward is much more positive.

He also recommends Woodside among the major oil producers and advises keeping an eye on Australian Worldwide Exploration, Arc Energy and Voyager Energy and the smaller end of the market for a suitable entry price.

Based on the lack of exploration in oil and base metals and continued demand from China, Singh advises investors to increase exposure to the resources sector in general and oil and gas in particular. Coal stocks have already had a good run, but he believes Australia's support for fossil fuels will further boost coal stocks. He likes Rio, BHP, Woodside Centennial Coal and Excel Coal.

In the industrial sector, McIntosh says investors should avoid high-priced growth stocks, reasoning that anything with a price-to-earnings ratio approaching 20 is already priced to perfection. However, he sees value emerging in abandoned stocks such as Mayne, Paperlinx and Southcorp.

Singh says investors should reduce their weighting of bank stocks, not just because they are sensitive to interest rate rises but also because they face pressure on profit margins.

Any fall in discretionary consumer spending due to higher oil prices and rates would hit retail stocks such as Harvey Norman and prompt a shift to retailers of consumer staples such as Coles and Woolworths.

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