Comment: Oil dropouts may make FTSE 100 more defensive

The quarterly FTSE 100 reshuffle on Wednesday will see an interesting change in sector representation, writes Augustin Eden of Accendo Markets .

Tullow Oil, whose shares have been in decline for three years and took a further beating from the recent collapse in oil prices to see it trading in a 75p range since the beginning of December, posted further losses on Monday as rumours of its impending relegation from the FTSE100 crept in.

It has taken a while for the effects of low oil prices to filter through and effect changes on the UK blue chip index and, for now at least, we are due to see a change in sector representation

Tullow posted its first pre-tax loss in 15 years last month and suspended its dividend in the process following a fall in market cap of 54% in 2014.

Those of its FTSE 100 siblings BG Group, BP and Royal Dutch Shell fell by 37%, 22% and 6.7% respectively.

Tullow is the only company bound for the FTSE 250 on Wednesday, a move largely seen as self-fulfilling given the powerful speculation pervading the press over the past two days.

It may not stay there for long, but its replacement Hikma Pharmaceuticals looks set to take its place and remain for the foreseeable future.

While some hedge funds continue to take short positions on oil, many analysts believe that the price of crude has hit its bottom and is recovering, albeit in a volatile manner and perhaps not headed back to the highs of last year.

The prevailing broker consensus on Tullow is in the strong buy region, reinforcing bullish ‘what comes down must go up’ sentiment on an essential industry.

All the while, though, capex cuts by oil majors and shrinking US rig counts are applying the pressure on producers to take the stuff out of the ground and to market in a cost-effective manner, and this is hurting those companies whose business it is to do so.

If the bulls are correct, it is likely that profitability will return and see the banished oil producer regaining blue chip status. They are supported by hopes that Tullow’s troubled plans for Ghanaian exploration will get the go ahead and Saudi oil minister Ali Al-Naimi who, practically declaring victory in round one of OPEC vs. USA, insisted in the last week of February that a sense of ‘calm’ had returned to the oil market and chided those who would rock the boat.

Hikma, a Jordanian drug maker, stormed the FTSE 250 and has been knocking on the 100 index’s door for some time. The pharmaceutical industry, like tobacco and alcohol, is traditionally regarded as more stable than the commodities sector.

Tullow is part of a volatile energy sector that makes up almost 15% of the FTSE 100. The volatility of the index can largely be put down to that heavy weighting.

While the shift in weighting will be unnoticeable for the time being, as Tullow is the smallest contributor to its sector representation and Hikma’s weighting in the index will be around 0.1%, continuing regulatory scrutiny and volatile commodity prices are likely to lead to increased pressure on energy stocks in the coming months. An increased presence of more stable, defensive stocks will make for an interesting change going forward.

Augustin Eden is a research analyst at Accendo Markets.