The oil industry is one of the world’s biggest and most important. Nearly all global travel still depends on refined fuels, and the coronavirus pandemic has brought global transport to a halt. As a result, oil demand is down 30% and expected to remain below peak levels for many months to come. At the same time, global oil giants have been very slow to cut output, resulting in record levels of oil and refined products in storage that’s only likely to keep growing. Production is expected to exceed demand for months and months.
As a result, oil stocks have been hit harder than any other. The Energy Select Sector SPDR ETF (NYSEMKT: XLE) is down 42% from the 2020 high, while the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEMKT: XOP) has lost half its value.
The oil industry has some tremendous opportunities for investors to profit, but with more tough times ahead, it’s also full of risk. So what’s an investor to do? We asked five veteran investors with experience following the energy industry to weigh in with their thoughts. Here’s what they had to say.
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Don’t lose sight of the basics
John Bromels: Right now, some oil producers are making complicated arguments about how they’re poised to succeed. As you listen to what they have to say, remember this: Fundamentally, oil production is a simple business. If you can pump a barrel of crude oil for less than its selling price, with overhead, taxes, and everything else factored in, you’ll make money. If not, you’ll lose money. Period.
Almost all producers have cut 2020 capital spending to preserve cash. Some point to debt maturity dates that are years in the future, implying everything’s fine until then. Others trumpet how many barrels of oil they’ve hedged, and at what prices. But all this is beside the point. If they can’t sell the oil they pump for more than it costs to pump it, they’re a losing investment proposition. Period.
Producing shale oil costs at least $50 per barrel in most cases. U.S. benchmark crude is trading at less than one-third of that price. Global oversupply and a lack of both demand and storage are likely to keep prices low for months, if not years. Unless a driller can answer convincingly how it expects to alter that equation in its favor, investors should stay away. Period.
Don’t go chasing dividend yields
Matt DiLallo: With oil stocks declining along with crude prices, dividend yields have gone up across the sector. Several payouts are now well into the double digits, which makes them seem enticing. However, I would caution dividend investors against buying what might turn out to be yield traps.
Because oil prices in the U.S. are below $20 a barrel and most oil producers aren’t making much money, they won’t be able to maintain their dividends much longer if oil prices don’t bounce back sharply in the coming months.
Meanwhile, even pipeline companies, which have limited direct exposure to commodity prices, are starting to feel the pinch as most producers are reducing their drilling activities, while many others are curbing their output. These moves will leave the companies with less volume flowing through their systems, which will eat into the fees they charge producers. And that will probably force financially weaker pipeline companies to reduce their high-yielding payouts.
While some oil dividends are worth buying, many of the sector’s payouts won’t survive this downturn. Income-seeking investors should focus more on a dividend’s ability to weather this storm than the size of the yield.
No harm in waiting around for a better opportunity
Tyler Crowe: I’m going to do that investment writer cliche thing and paraphrase a Warren Buffett quote: There are no called strikes in investing. That message is true for all investing, but that message is especially pertinent today in the world of energy.
With oil prices at generational lows and the physical infrastructure to store oil and gas testing new limits each day, it’s abundantly clear that companies in this industry are in for a world of pain this year and potentially into next. Even if oil prices were to start climbing, the companies that produce the stuff are still losing money per barrel sold, which will have ripple effects throughout the industry.
You may want to invest in a future where demand gets back to where it was and the glut of inventory clears. To do that, though, the company you’re investing in needs to get through this time without incurring significant financial damage. Taking on significant debt to survive the downturn could have much longer-lasting impacts on a company’s profitability than low oil prices.
There’s no harm in waiting for the dust to settle here. Your portfolio can’t get worse if you elect to wait, but it certainly can get worse if you try to make some speculative bets on who the survivors in this industry will be and they don’t pan out.
There’s no looking back
Travis Hoium: It’s easy to think that oil will bounce back within the next few months as demand rebounds and the oil business — and their stocks — will come back with it. After all, when people start driving again and the economy recovers, demand should be more or less where it was a few months ago. But that recovery is far from guaranteed, and the oil supply may be changed forever.
The pressure hitting U.S. shale and offshore markets is going to leave dozens of companies out of business and result in a drop in oil production in formerly booming shale regions of the country. Oil producers, pipelines, and service companies will all be negatively affected.
But the impact may not be temporary. Debt drove a shale drilling oil boom, and creditors aren’t likely to be interested in making that mistake again. And Saudi Arabia appears to be willing to drive oversupply of oil markets long enough to permanently alter the balance of world oil power. On the demand side, business isn’t going back to normal next month; some workers may not return to offices ever if working from home proves successful.
Looking at where we’ve been to predict where we’re going isn’t wise with oil stocks. Both the supply and demand of oil may be changed permanently.
You don’t catch fish in a graveyard
Jason Hall: Many other industries have seen their stock prices recover much of their losses, but oil stocks have fallen sharply and many have stayed beaten down. Sadly enough, a lot of investors have plowed money into some of the most troubled companies in the oil patch, looking to profit on the eventual recovery in oil demand and the rise of oil prices.
I won’t get into the details — my colleagues have already covered things quite well — but the oil market hasn’t bottomed out yet. Sure, oil prices went negative on April 20, but the reality is, the oil supply/demand imbalance has only worsened since then as producers continue to pump more oil.
Let me put it bluntly. April 20 was not the bottom of the oil market.
With each passing day, the oil glut grows bigger. Global oil production still exceeds demand by millions of barrels every day. We will probably see an oversupply imbalance for months to come. The worst of the damage is almost certainly still in the future.
Yet many investors continue to buy the stocks that have fallen the most, even as the number of oil stock bankrupties grows. Here’s the bottom line: The cheapest oil stocks — in terms of how far their stock prices have fallen — are cheap for a reason. Instead of making bets on stocks with the most risk, a better way to profit from the oil crash is to invest in the companies built to succeed even in with today’s low oil prices.
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Jason Hall has no position in any of the stocks mentioned. John Bromels has no position in any of the stocks mentioned. Matthew DiLallo has no position in any of the stocks mentioned. Travis Hoium has no position in any of the stocks mentioned. Tyler Crowe has no position in any of the stocks mentioned. 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.