Should you buy oil stocks now?

Oil price 4Dear Mr. Market:

Just a few short months ago we experienced the seasonal sensation known as Black Friday where consumers lose grasp of reality all in the search for a great deal. People camp overnight on sidewalks in an effort to be one of the first shoppers inside a big box store and take advantage of a bargain they can brag about to all their friends. Buying a large screen television at 50% of retail is certainly exciting but do the same individuals get excited when the equity markets present similar opportunities?

Investors display behavior that is nearly a complete opposite when the markets or an individual stock drop in price when compared to a retail store sale. Rather than racing to get in a store at the crack of dawn they dash for the exit, submitting sell orders as quickly as they can with no rhyme or reason. Throughout various market cycles and economic environments Mr. Market presents investors with buying opportunities yet few actually take advantage of them. You don’t have to look far to find a sector that has experienced a price reduction of 50% in the last six months (the majority of that correction taking place in just the last three months!). You would have to be living ‘off the grid’ or under a rock to not realize that what we are talking about is oil.

It was only 12 months ago that oil was priced around $100 per barrel. Currently the West Texas Intermediate (WTI) is priced around $46 per barrel but when you look at how quickly it has fallen in the last three months it is even more shocking. It was priced at over $80 per barrel the first week of October and at $107 mid summer!

The rapid decline in oil has had a profound impact not only in the United States but also around the globe. Russia has been hit extremely hard as half of their national budget depends on $100-per-barrel oil. Just in the last 45 days their currency has fallen more than 30% when compared to the dollar. While the impact in Russia has been profound the decline in oil should provide a bit of a boost to other countries, saving them hundreds of billions of dollars.  The EIA (U.S. Energy Information Administration) estimates oil consumption during the second half of 2014 was 6.9 billion barrels. The drop in oil from the June 2014 high of $107 results in a savings of $414 billion. This should be viewed as another catalyst to countries that are attempting to jumpstart their economies, especially in several emerging market economies.

The U.S. consumer has been enjoying the reduced price of oil/gas as they are finding more money in their pockets to spend at their discretion after filling up their gas tanks. Currently over half the country (28 states) is reporting gas priced at under $2 a gallon. As we find ourselves in the middle of winter, consumers are spending more on a gallon of windshield wiper fluid then they are on a gallon of gas! Tom Kloza, senior energy analyst for the Oil Price Information Service, expects gasoline prices to average around $2.45 in 2015. As a result, the nation’s gasoline bill would drop from about $460.5 billion in 2014 to about $340 billion this year. That is a difference of $120 billion – if these dollars are put to work it could have a dramatic effect on our economy.

Oil has rarely experienced a rapid decline like what we are currently experiencing; in fact it has only happened five times in the last 35 years. According to CNBC, six months after a 50% decline in the price of oil, the S&P 500 was up four of the five times, with an average gain of 3.7%. What is even more important to note is that WTI was positive six months later all five times, up 52% on average! We are certainly in a different world economy currently and data from the past is not indicative of future performance but very few (if any) analysts are making a prediction that oil will stay at these levels or lower for the foreseeable future. This leads us to the ultimate question, what is the best strategy for adding oil exposure to your portfolio?

As we have discussed before there are so many options available to investors these days when looking at a specific sector of the S&P 500, it can often be overwhelming. The first one that we would quickly remove from the list of viable options is mutual funds. According to Morningstar the top 10 energy focused mutual funds have an average expense of 1.09% and offer a yield of .64%. When you consider that on average over 75% of actively managed mutual funds do not beat their respective benchmark it is an easy decision to toss out mutual funds as an intelligent option. For those that would like to have broad based exposure to the energy sector consider looking at Exchange Traded Funds (ETF’s).

The top 10 energy ETF’s (according to ETF Database) have an average fee of .41% with a yield of 1.92%. A quick comparison reveals that the fee is less than half and the yield is more than double of the average mutual fund. It is important to note when looking at broad based investment vehicles that you will be capturing exposure to the entire industry. For example, in the energy sector you will not only have added oil & gas to your portfolio but you will also have exposure to natural gas, drilling/exploration and integrated power companies. If you are looking to add primarily oil and gas oriented companies make sure that you perform the due diligence to research what the top holdings are and what the investment strategy is with each broad based investment option.

The other option to consider is adding individual oil and gas company stocks to your portfolio. We will focus on large companies that have a history of paying and growing their dividends, producing higher earnings per share for their investors while also maintaining a favorable ranking with analysts. Please keep in mind that our commentary below is not a specific recommendation for your investment portfolio as we are not familiar with your specific goals or risk tolerance.

Chevron (CVX) current price: $106 with a yield at 3.93%

Currently the smallest of the world’s five “Super Major” oil companies and the second largest U.S. based energy company. Considered an integrated name as it has operations in exploration, production and refining. The company came into existence with the 2001 merger of Chevron and Texaco. There are currently 26 analysts following and issuing an opinion on CVX only two of them have it ranked as ‘underperform’ or ‘sell’ the rest have it as a ‘hold’ (12), or ‘buy/strong buy’ (10).

ConocoPhillips (COP) current price: $65 with a yield at 4.47%

Global oil and gas company with business in over 25 different countries. The company produces, transports and markets crude oil and natural gas products on a worldwide basis. Currently there are 24 analysts following COP. Only one has it rated as a ‘underperform’ the rest have it rated as a ‘hold’ (9), ‘buy’ (7) or ‘strong buy’ (7).

Suncor Energy (SU) current price $30, yield at 3.31%

Canadian based company that merged in 2009 with Petro-Canada. The company focuses on the developing petroleum products from Canada’s Athabasca oil sands and explores, develops produces and markets crude oil along with natural gas internationally. Six analysts are currently issuing a recommendation on the company with one at a ‘hold, four at a ‘buy’ and one with a ‘strong buy’ rating.

If you are not comfortable picking individual stocks and managing them effectively you should consider broad diversification using sector specific ETF’s. Below are three of the largest and more popular ETF’s currently available to investors:

Vanguard Energy Index Fund (VDE) current price $108, yield at 2.03%

Top five holdings: Exxon Mobil (XOM), Chevron (CVX), Schlumberger (SLB), ConocoPhillips (COP) & Kinder Morgan (KMI). Fee = .12%

iShares Oil & gas Exploration/Production (IEO) current price $69, yield at 1.34%

Top five holdings: ConocoPhillips (COP), EOG Resources (EOG), Anadarko Petroleum (APC), Phillips 66 (PSX) & Valero Energy Corp (VLO). Fee = .45%

Energy Select SPDR (XLE), current price $77, yield at 2.41%

Top five holdings: Exxon Mobile (XOM), Chevron (CVX), Schlumberger (SLB), Kinder Morgan (KMI) & ConocoPhillips (COP). Fee = .16%

Looking forward…

We don’t attempt to read the ‘tea leaves’ or make predictions when it comes to the markets or specific sectors. What has proven to be a time tested strategy is having a disciplined strategy with a focus on asset allocation. If a strategy is in place it will force investors to buy what is out of favor and sell what has performed well. To quote one of the most successful investors of our era – Warren Buffet, “I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now, what is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up.

Often investors will identify an investment that they would like to add to their portfolio but struggle with both the entry point and exit strategy. By having an asset allocation strategy in place the guesswork is removed and the decision should be much easier as it is simply a matter of rebalancing the account. When looking at a sector like energy it is often challenging for investors to decide when to buy as they feel like they are catching a falling knife with the volatility in the price of oil. If you find yourself struggling with this consider buying half or a third of your target amount and then add to it on market dips until you have a full position.

Oil price 1Mr. Market will frequently present investors with buying opportunities driving prices down to what could be bargain levels. Often they disappear as quickly as they present themselves to investors. Will you be a wise shopper or will you be racing for the exit?

 

2 thoughts on “Should you buy oil stocks now?

  1. I thought he would’ve held on or bought more. I believe this oil slump will recover. How long? I dont know but a strong company like ExxonMobil should be able to weather it out.

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