Most people think investing in natural resources companies is about having a punt at whether someone has made the next big oil, gas or mining discovery.
Take a closer look at the industry and you'll realise there are much more solid reasons to participate.
Investors can gain indirect exposure to commodity markets and could benefit from demographic trends like population growth and a growing middle class in developing economies which are driving increased demand for finite amounts of energy and raw materials.
What’s included in this sector?: Companies which look for, extract, market and sell the world's major commodities.
Some firms only take one or two of these roles, while others - in particular large integrated players like BP (BP.) and Royal Dutch Shell (RDSB) - address all of them. It also includes services providers which support these companies in their daily operations.
The industry: The resources industry is enormous and ultimately provides the materials and energy behind nearly everything we use on a day-to-day basis. It faces significant environmental and political challenges in the 21st Century.
Risk profile: This is a cyclical sector and its fortunes fluctuate in line with commodity prices which are for the most part dictated by the global economy.
Fast growing economies like China, the biggest consumer of many of the world's commodities, have a particularly strong influence.
There is also a risk that countries may assert ownership over the resources located within their borders - something known as resource nationalism.
The objectives you might have for investing in this sector: The case for investing in commodities is that a growing global population will consume more of the world's limited store of resources - particularly as consumption per head is increasing in countries like India and China.
If you are looking for exposure to crude oil, natural gas, coal, uranium or metals it could make sense to buy shares in a company which is engaged in the exploration and production of these resources.
As well as tracking the price of the respective commodities they exploit, the share prices of these miners and oil companies will respond to operational performance.
This offers the prospect of greater upside if a company performs well but also risks more significant downside if it encounters setbacks
Exploration companies can see rapid share price appreciation in the event they discover new reserves of oil and gas or a new metal deposit but can also fall just as rapidly if they are unsuccessful.
Miners and, in particular, oil and gas companies are also big contributors to the dividends on offer from the UK market.
Higher profile companies in this sector:
Royal Dutch Shell (RDSB) - Has a long-term strategy of focusing on the natural gas market
BP (BP.) - Since the Gulf of Mexico disaster in 2010 has transformed into a more streamlined operator
Rio Tinto (RIO) - Principally based in Australia and Canada, it is the world leader in the production of several commodities
Glencore (GLEN) - Glencore merged with Xstrata in 2013 adding mining assets to a commodities trading operation
BHP Billiton (BLT) - Mainly focused on mining but has some oil and gas assets, too
Affected by:
Commodity prices
Scarcity of resources
Consumer spending
The main factor which influences the profits and revenues generated by companies in this sector is commodity prices.
These in turn are dictated by supply and demand. On the supply side, it is becoming increasingly difficult to find oil and gas, which has led to a focus on so-called 'unconventional' resources like shale oil and shale gas.
Demand is rising as the global population increases and consumption per head builds in emerging markets. The growth of electric vehicles is a potential threat to oil demand.
Affects:
Industrials
Energy and raw material costs
If the resources sector is doing well and commodity prices are high then this can put industrial companies - which are particularly heavy consumers of energy and raw materials - under pressure.
On the flipside, some parts of the industrial sector provide services and products the oil and gas industry.
Numbers to watch out for:
Capital expenditure - how much companies plan to spend on developing new projects
Ore grade - An ore is a type of rock that contains minerals and metals which can be extracted. The grade describes the concentration of metal and plays an important role in determining the costs of extraction
Operating costs per barrel - How much a company spends to produce each individual barrel of oil
Baker Hughes Rig Count - a widely followed measure of industry activity, this is released as two separate figures showing how many drilling rigs are operating in North America and worldwide
Reserves replacement ratio - measures the extent to which the company replaces reserves lost to production
Proved and probable resources - reserves of oil and gas which geological analysis suggests are more likely than not to be recoverable
Relevant ETFs:
iShares US Oil & Gas Exploration & Production (SPOG) - Provides exposure to US companies engaged in the exploration, production and distribution of oil and gas
iShares Gold Producers (SPGP) - Tracks the largest publicly-traded companies involved in the exploration and production of gold and related products from around the world
