As Bad as Oil Stocks Have Been, Are They Worth a Look?

Oil Stocks

Good stock selection always involves seeking better than average opportunities. Oil stocks have been way below average for a long time, but is there a reason to be optimistic?

It is no secret that the oil and gas sector has fallen out of favor, and it’s no surprise either considering how tied this sector is to oil prices and what has happened with them over the last few years.

Oil once traded as high as $147 a barrel back in June 2008, but the dynamics of the industry has changed a lot since then and this has really been reflected in its price. We once thought that the price of oil would just keep going up and up as demand for it increases and supplies continue to dwindle. Demand has kept up, but supplies have increased quite a bit since then, and this means lower prices.

The price of oil has also been subject to a lot of manipulation over the years, in a semi-monopolistic fashion, where OPEC would withhold production to keep prices up, but OPEC’s role has really diminished these days. The top 4 oil producing countries are now the United States, Russia, Saudi Arabia, and Canada, and only Saudi Arabia is part of OPEC. The other countries pursue their own interests independently and are more willing to take their oil to market instead of sitting on a lot of it and this has made a big difference in oil prices.

OPEC even engaged in a price war with the United States and other big producers, and Saudi Arabia still has the world’s largest oil reserves and can pump out a lot more if they want. The price of a barrel of oil fell all the way to $27, and the idea was to lay a beating on the shale oil industry, which is more expensive to extract, but the shale business held and Saudi Arabia had to back off in defeat.

Oil now sits at about twice this price, around $58 a barrel for the international standard, Brent Crude, and while OPEC wants to raise the price to about $80, they just don’t have the clout that they once had. This is more a matter of the market expanding so much that manipulating the price of oil is a lot harder to do now than in the old days.

This is not to say that oil won’t be back up to the $80 range soon, and oil prices rising is certainly good for oil stocks, as this directly affect their bottom line, but we can’t just go by guesses here.

The U.S. EIA, whose job is to forecast these prices, does see us getting to $80 a barrel, in 2025 that is. There is a lot of uncertainty with predicting oil prices though and in order for it to make sense to put money on predictions, we need a lot more certainty than these forecasts can provide.

Even if we do see this though, based upon the effect of similar oil price increases in the past, this isn’t likely to have much of a breakout effect upon oil stocks, and such a move over a 6-year period would well underperform the market should it move along at its normal pace. We always want to assess the desirability of an investment by way of its opportunity costs, and when one underperforms and is expected to underperform the market, this makes it a poor choice.

The Oil Sector Has Performed Terribly, and There’s Little Evidence to Think This Will Change Much

Over the years, this all has caused the sector to become left behind in a pretty dramatic way. The S&P 500, which is patient enough but really doesn’t want to be full of laggards, has scaled back the energy sector over the last 40 years, from 25% to now representing less than 5% of the index. This is not a coincidence as these stocks simply haven’t been cutting it and it is also clear that they very likely won’t be anytime soon either, if ever.

The decline in the sector has been particularly noticeable during the last 5 years. Over this time, the broader S&P 500 is up 47%. The S&P Oil and Gas Exploration and Production index has simply been hammered, losing 75% of its value over this time.

The broader industry focused Energy Select Sector Fund, with about half of the fund comprised of Exxon Mobil and Chevron, has lost 42% over the last 5 years. Chevron, the pick of the litter, has only lost 12% during this time, which is less disappointing than the industry average but still disappointing.

This doesn’t mean that these stocks don’t have their moments in the sun at times, but we need to realize that we’re essentially investing in commodities in the same manner as we might want to play gold stocks as a proxy for gold itself.

You can’t really just buy commodities long term and we shouldn’t ever be doing that with commodity stocks either, even though a lot of people do. It is common for investors and their advisors to know little about what they are doing though.

The time to be holding these plays, if such a time does even come, would be when oil is clearly rising in price. This is not what is happening now so that alone is plenty enough to not want to enter any of these stocks as well as exit if we are in them. This is not a matter of wondering about our losing money going forward, it is more a matter of wanting our money in investments that are going to perform for us.

This is an aspect of investing that is missed by individual investors a lot, and even by professional ones to a large degree. They may hold because things might not look too bad with their stocks right now but not too bad wilts in comparison with the pretty goods and especially the greats. With the very minimal trading costs we have these days, if our money is better put elsewhere, we need to put it elsewhere and not just cling to our mistakes or trades that may have been good at one time, but the good part of them has passed.

Good Investing is All About Seeking Good Returns with Lower Risk, Oil Delivers Neither

It is fine to speculate on things such as the price of oil, but we need to account for both the likelihood of return and the risks involved. Since oil is so volatile and unpredictable, it’s not that easy to predict what returns we will get beyond riding a short-term move, and this unpredictability adds risk to the trade. Since we need to be striving for more certainty and less risk, oil or oil stocks just don’t fit the bill very well at all beyond the short-term horizons that appeal to traders but not investors.

When we put oil on a monthly chart, one suitable to longer-term positions such as several years, we are actually in a downtrend right now, from last September when we were up around $83. Shorting oil here would have been a good move back then, but since we’ve moved down to about $55 now, we’re starting to run into some resistance around $50 and there just isn’t enough upside to make a short entry here worth the risk.

People are clamoring to go long oil stocks right now though although we have no business doing that unless oil is on the way up. If we were looking to buy stocks instead of oil, Chevron would probably be our best bet, but it’s been beating around a range for the past two years and is pointed in the wrong direction right now as well, so this is one of many potential opportunities that just don’t have anywhere near a good enough reason to want to pursue.

Oil will be moving up at some point, although the idea with trading commodities or commodity proxies is that you actually have to see a move at least start before you should even be thinking of jumping on the ride, regardless of what our crystal balls might say. We should never be relying on what amounts to guessing with investing and the crystal ball we use to predict oil prices is cloudier as well, like one with a film of crude oil on it blurring our vision would be.

We should never be investing on a wing and a prayer, and doing this with oil stocks requires even bigger wings and bigger prayers than normal stocks. There’s enough uncertainty with investing for us to want to court it like we would be if we just jumped on the long side of oil stocks right now.

Ken Stephens

Chief Editor, MarketReview.com