2 best oil stocks to buy long term

Countries around the world are looking for ways to reduce carbon emissions, which is great and a testament to the growth in clean energy today. Only switching from carbonaceous fuels like oil and natural gas to cleaner alternatives like wind and solar isn’t as easy as flipping a switch. Even in the most aggressive clean energy scenarios, oil and natural gas will be important parts of the global energy pie for decades to come.

There are two ways of playing this space right now – one with a focus on today and one with more focus on a cleaner future.

1. We know this stuff works

Investors looking to invest in energy are probably better off with a large and diverse name like Chevron (NYSE: CVX). The business of this integrated energy giant stretches from the upstream sectors (drilling) to the downstream sectors (chemicals and refining) and everything in between. This diversification of the portfolio generally makes it possible to attenuate the fluctuations inherent in the oil and natural gas markets, with downstream activities often benefiting from lower commodity prices.

Chevron, meanwhile, adds an extra layer of security, with a cautious balance sheet and a lower debt ratio than its closest peers. This remains true even after an opportunistic acquisition made during the industry downturn in 2020.

Image source: Getty Images.

This acquisition is significant here, because it essentially means that Chevron has doubled in the energy patch despite the global push for clean energy. It’s not that the company ignores environmental issues, but simply that it still believes the best returns are to be found by sticking to its historic knitwear. And that means a continued focus on oil and natural gas. Remember, oil and natural gas have been very profitable over time: Chevron has a streak of more than three decades of annual dividend hikes under its belt. That includes an increase in the 2020 pandemic and another in 2021. It’s not something a weak and struggling business is doing.

Meanwhile, Chevron has a strong portfolio of projects underway that will not break the bank but will maintain production growth for the foreseeable future. As long as oil remains a staple of the energy landscape, Chevron appears to be a significant player – and, if history is any guide, a rewarding investment option for investors. Today’s dividend yield, meanwhile, is at an all-time high of 5.6%, suggesting stocks are cheap right now. If you think the oil is around for at least a few more decades, then highly concentrated Chevron is a good bet.

CVX dividend per share graph (quarterly)

CVX data on dividend per share (quarterly) by YCharts

2. Cover your oil bet

That said, it’s hard to deny that clean energy is gaining in importance. It will eventually replace oil as the dominant energy source globally. That’s why some investors might prefer to avoid Chevron and instead focus on an integrated oil giant that has already started changing its portfolio to include more clean energy assets. An interesting name on this side of the equation is Royal Dutch Shell (NYSE: RDS.B).

To be fair, Shell had a rough start on the clean energy front. It cut its dividend around the same time it announced it would refocus its business to include more investment in clean energy. It was a big change – Shell was basically looking to hit the reset button so it could more easily adapt with the world around it. At the time, she said she wanted to resume dividend growth as soon as possible. It has since increased the dividend three times, clearly respecting this commitment.

Due to falling dividends, the stock’s return is around 3.8%, which is at the bottom of its peer group scale. However, the outlook for continued dividend growth is attractive after the dividend reset.

There are a lot of moving parts, but Shell wants to reduce its upstream activities from 42% of its capital expenditure in 2020 to only about 25% in 2025. Large oil projects are expected to decline in favor of investment in natural gas, a burn fuel which should help the transition to clean energy. Meanwhile, “transition” and “growth” businesses, which are largely cleaner in nature (including things like electric vehicle charging stations) are expected to see their spending increase significantly, from almost 60% of spending in 2020 to up to 75%. Taking a step back, Shell is primarily using its cash cow oil and natural gas production activities to finance its transition to clean energy. If this sounds like a winning mid-point plan, then Shell and its return to dividend growth might be the right energy choice for you.

A work in progress

Of course, the world is at the heart of a major energy transition. It won’t be quick and it won’t be smooth, which means there is ample opportunity for investors to continue to own and profit from energy stocks.

If you think oil still has a very long way to go, Chevron is probably the best-positioned energy giant to own. If you want to hedge your oil bet a bit, then Shell, which rewards investors with dividend growth, might be the best option. However, both are important names in the industry that you should be able to hold onto for years to come.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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Felix J. Dixon