Is it too late for oil stocks?

Since the oil and gas crash of 2014 and 2015, the industry has for the most part not been favored by Wall Street. Between 2017 and 2020, the energy sector produced a negative total return of 39% compared to the market gain of over 80%, taking the meaning of underperformance to a whole new level.

But in 2021, energy has so far been the best performing sector, as oil cuts in Saudi Arabia pushed West Texas Intermediate (WTI) crude oil prices above $ 50 for the first time. since February 2020. Let’s take an in-depth look at the sector to see where the oil is going, if it’s worth investing – and if so – which stocks are the best buys right now.

Image source: Getty Images.

Oil price

We cannot discuss oil stocks without talking about oil prices.

WTI crude oil prices ended 2019 around $ 60 a barrel before briefly dipping into negative territory in late April 2020 as demand fell off a cliff due to the COVID-19 pandemic. Here is the average price of WTI crude oil over the past five years.

Metric

2020

2019

2018

2017

2016

Average spot price of WTI crude

$ 39.23

$ 56.98

$ 64.94

$ 50.88

$ 43.14

Date source: US Energy Information Administration

In many ways, oil prices reflect the balance between supply and demand. Oil prices are rising because the global supply is shrinking at a time when the global consumption of fuels for land and air transportation could experience a steady increase throughout the year. But it wasn’t that long ago that oil was in the $ 30 range.

On November 9, the stock market soared on possible vaccine news from drugmakers Pfizer and BioNTech, sending WTI crude oil prices above $ 40 a barrel. Even from that jump, there were still four reasons why crude oil may continue to rise.

In summary, increased demand for crude oil and refined products could exceed supply in the near term. Producers of large and small cuts in the second and third quarters of 2020 in response to lower demand. Since supply cannot come back overnight, higher demand could push prices up in the short term. In the long run, many publicly traded companies cut spending to focus on sustaining existing production, leaving little room for production growth. However, the national oil companies (NOCs) retain control of the majority of the global supply, leaving a level of uncertainty in the market.

Yet years of declining spending coupled with growing global demand could drive up prices. And finally, companies, especially the majors, are cutting oil and gas spending in favor of renewable investments. PA, for example, plans to produce 40% less oil in 2030 than in 2019. Permanent cuts could reduce supply further.

XOM Capital Expenditure Table (TTM)

XOM Capital Expenditure Data (TTM) by YCharts

The benefits of higher oil prices in the short term, coupled with what could be a reduction in supply in the long term, are partially offset by lower demand for oil. The latest global energy outlook from the International Energy Agency suggests that demand for oil may start to stabilize in 2030 at around 103.2 million barrels per day.

Cost efficiency

Oil price movements are beyond a company’s control. However, companies can position their investment portfolios in equilibrium at lower oil prices, which can help mitigate losses during downturns and capitalize on uptrends. Several companies are well positioned to cash in $ 50 in crude oil, in large part because they made timely acquisitions and shifted their portfolios to their most profitable assets. Many of the top upstream producers say they can now break even into $ 40 or $ 30 per barrel. It remains to be seen whether a producer can consistently make a profit even at this low price. But if that’s true, then $ 50 a barrel would be the point where Free Cash Flow (FCF) would start to take off, paving the way for dividend increases and more investment.

What to avoid

Efficient operations can make a great oil company, but not if it comes at the expense of high debt. Companies like Western Oil achieved lower breakeven costs per barrel, but it did so at the expense of its balance sheet. High debt securities at high interest rates are a recipe for disaster. It is better to avoid heavily indebted oil companies, even if they have efficient operations.

What to look for

The energy sector is full of risky players with questionable balance sheets. But there are a handful of energy stocks with high dividend yields, low leverage, and efficient trading. Given the volatility of oil prices, the key is to prioritize financial health and low debt. For example, Chevron has arguably the best record of the oil majors, which supports its stable and growing dividend (currently making more than 5%). Texas Pacific Land Trust is another more secure oil stock. She owns 900,000 acres in West Texas, has no debt, and $ 300 million in cash. It benefits from the higher oil prices without having to spend a lot of money, as companies tend to drill more oil and build more pipelines through its lands when prices rise.

Aside from the upstream producers, the middle industry is known to have stable and reliable sources of FCFs and high dividend yields while being less exposed to commodity prices. Likewise, utilities with regulated revenue sources may also be a better energy investment than oil stocks for dividend investors.

Take away food

The short answer is, it’s not too late for oil stocks, but the industry is rife with companies with too much debt and too little potential. Even if oil consumption stagnates in 2030, supply is unlikely to exceed demand as some oil companies invest less in oil and more in renewables. Therefore, finding companies with low debt, high FCFs that support their dividends, and efficient operations is the best long-term method of investing in oil stocks.

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Daniel Foelber owns stock in Chevron and has the following options: $ 85 short-term calls in June 2021 on Chevron. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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Felix J. Dixon