The price of crude oil has recovered most of the losses experienced in late 2018, leaving both West Texas Crude and Brent Crude trading in the mid to high $50 range. This is still well off the $100 level we saw earlier in the decade, but also higher than the $40 support zone.
So, should you invest in oil stocks now? It does appear the oil price is recovering, but there are still risks. If all else remains equal, the price shouldn’t fall too much, while it’s quite possible that it may head back to $100 in the next few years. Investing in oil stocks is still a little risky, but the potential upside should outweigh the risks.
The supply and demand cycle
Like any commodity, the price of oil depends on supply and demand.
Over time, while the global economy is growing, demand increases. Various forms of renewable energy are meeting some new demand. For now, this is a minor consideration, but it will increase with time.
When oil prices rise, new investments in exploration and extraction are made. Supply then increases until it outstrips demand at which point prices begin to fall again. If the price falls a lot, producers with high production costs may cease producing. This leads to falling supply, and eventually, the price begins to increase again.
This cycle is also affected by inventory levels, new discoveries and geopolitical issues which can cause supply shocks. This is the reason the factors that affect the oil industry are so dynamic.
Risks to investing in oil stocks
Chasing the stocks with the highest dividend yields is a mistake many investors make when choosing oil stocks to invest in. If it turns out that the company cannot afford to keep paying that dividend, the stock price will plummet. Dividends are great, but you need to make sure the yield is sustainable for the company, particularly if the oil price falls.
The price of oil stocks usually reflects the market’s assumptions about the future direction of the oil price. If anything changes suddenly, stock prices will adjust to affect new assumptions. Anything that may affect either supply or demand can affect stock prices.
An unfortunate reality in the oil extraction industry is that oil spills and other disasters do sometimes occur. These can have a catastrophic effect on a company’s oil stock. This is why investors should always diversify across a handful of oil producers.
When to buy oil stocks
When oil prices rise, the more marginal producers engaged in oil and gas extraction gain the most. Obviously, these companies also have the most to lose when oil and gas prices fall.
When prices fall, most energy stocks suffer, but some are more resilient than others. Producers with low production costs can carry on producing profitably. They can even benefit when marginal producers cease production. Diversified producers are also more resilient as they earn margins throughout the supply chain.
When oil prices are relatively high, its best to stick with the diversified producers which are more resilient. If prices fall to historically low levels and then begin recovering, you can consider the high-cost producers which have the most to gain.
Oil stocks to watch
The following US oil stocks are all listed on the One Financial CFD trading platform and are worth watching over the next few months.
Diamondback Energy Inc. (Fang) explores and develops both oil and gas reserves in the Permian Basin. This is one of the riskier stocks in the sector, but the price has fallen 25% in 2019 so there is less risk than there was a year ago. The company has cut costs and is increasing its production levels. It is well-positioned if oil and gas prices remain stable or rise and sell-side analysts are very bullish on the stock.
EOG Resources Inc. (EOG) operates in the US, Canada, and China. The company has generated enough cash to invest heavily in capacity, pay off debt and still pay a dividend. EOG now produces close to 500,000 barrels of oil a day. This stock does need higher prices to justify the stock price but will rise quickly if the oil price rallies.
Exxon Mobile (XOM) is the largest oil producer in the US. The company is also more defensive and can tolerate lower prices better than most. Exxon has a strong pipeline of new projects coming on stream which means it production will continue to grow in the future. Exxon also has a 5% dividend yield with enough cash flow to cover its yield.
Cimarex Energy Co. (XEC) is a smaller producer with a market value of just $4.6 billion. It operates in Texas, Oklahoma, and New Mexico where it explores and extracts oil and gas. It has new production coming onstream soon and should perform well in 2020. Because of its size, Cimarex is also viewed as a buyout target.
Of course, oil stocks are not the only way to play the energy market. You can also trade both oil and gas directly with CFDs on the One Financial Platform.