Which oil companies for the long-term?

[mpi2008]

Evening folks,

I have looked at oil/energy sector companies in the last few weeks as potential long-term investments for myself and my LTD company. The plan is to hold for several years or possibly longer in the hope/expectation that better times will lie ahead. Unfortunately, the oil/energy sector is not well known to me but the obvious opportunities in oil/energy stocks speak for themselves just now whilst prices are depressed. I am not looking to ‘catch a falling knife’ or recklessly send my money soldiers to their graves. Instead, I'd like to build a sizeable position in strong oil/energy sector companies whose price declines have been disproportionately affected by the oil supply/demand problem which temporarily prevails.

I do not wish to be get drawn into an in-depth discussion of any individual company's pros/cons at present or future prospects for oil prices but I recognise that an appreciation of this (includng the balance sheet) should be an important consideration for all investments.

At present, I am merely seeking a superficial appreciation of those companies that oil/energy investors would consider 'a good bet' for durability and strong upside potential going forward as I have no interest just now in ETFs, spread-betting or betting on oil futures. I am not closed off to a few more speculative and higher risk oil stocks too but have seen the unfortunate annihilation of Afren Plc's share price this morning and a domino-effect of smaller oil/energy company bankruptcies is obviously a concern.

From my research so far, I have compiled the following list of potential oil/energy stocks:

'Strongest' stocks (as per my understanding)- Royal Dutch Shell, Schlumberger, BP, Chevron, Conoco Phillips, Halliburton, Baker Hughes, Ultra Petroleum, Exxon Mobile, EOG, Total.

Riskier and other - National-Oilwell Varco, WPX Energy, Core laboratories, Tidewater, Occidental Petroleum, Suncor energy, Petroleum Resources, Tullow Oil, Cairn energy, Petroceltic International, Ophir Energy, Genel Energy, Dragon Oil, Premier Oil.

I've noticed that most of the stocks in the second category (and many in the so-called 'strong' stock category too) have fallen by at least 30%. I am sure many will argue that some in the second category should be in the 'strong' category and vice versa. I am looking to drill down (no pun intended!)to perhaps 5 or 6 stocks overall in which I will spread my investment.

I realise companies like Exxon Mobile, Chevron and Royal Dutch Shell are obvious candidates due to their mass, dividend payouts and solid balance sheets however I am probably most interested in that rare blend of stability and potential for significant growth as dividend payouts are not my principal concern.

If anyone is willing to comment on any of the above stocks (or mention their own) in relation to their suitability (or lack thereof) as a suitable long-term investment in this sector, then their comments/insights would be greatly appreciated. If not then thanks for reading.

Kind Regards

 

[Jack o'Clubs]

In coming to a conclusion, I think there are two things you don't want to include in the discussion which are actually critical to coming out at the right point.

First, and most obvious is the oil price itself. If fundamental investing is about working out your own valuation for an asset and then seeing if the price given it by the market allows you upside, then to value an asset you need some view on cashflows and/or earnings. The starting point for that is revenues, and you can't have a stab at revenues without a view on the oil price. There are good reasons to think that sub-$50 is 'the new normal'. Absolute demand for oil is falling (that's unprecedented in recent times). That's a function of three trends which aren't going to reverse: i) slowing global growth (and US pickup isn't going to offset China, especially as China's slowdown is partly a managed process to transition away from an export driven economy to a consumer demand led one. ii) increasing fuel efficiency. Think how passenger car MPG has moved over the last five/ten years and then imagine that writ large across all industrial users of oil. iii) alternatives. Not just the tree-hugging types, but coal-to-gas projects etc (coal is also in structural oversupply). Put all those together and it's hard to see a demand led reason why oil prices recover from here.

Second, is a lack of interest in company dividends. The problem is, a huge amount of this sector is owned by equity income funds, and if the dividends are cut then they become, at worst, forced sellers. Diividend sustainability should be a key part of the analysis.

Putting that together, and imagining oil staying below $50, then you want the strongest balance sheets, growth is irrelevant. Those names (in Europe at least) are Repsol, BP, Shell and Total.

 

[mpi2008]

In coming to a conclusion, I think there are two things you don't want to include in the discussion which are actually critical to coming out at the right point.

First, and most obvious is the oil price itself. If fundamental investing is about working out your own valuation for an asset and then seeing if the price given it by the market allows you upside, then to value an asset you need some view on cashflows and/or earnings. The starting point for that is revenues, and you can't have a stab at revenues without a view on the oil price. There are good reasons to think that sub-$50 is 'the new normal'. Absolute demand for oil is falling (that's unprecedented in recent times). That's a function of three trends which aren't going to reverse: i) slowing global growth (and US pickup isn't going to offset China, especially as China's slowdown is partly a managed process to transition away from an export driven economy to a consumer demand led one. ii) increasing fuel efficiency. Think how passenger car MPG has moved over the last five/ten years and then imagine that writ large across all industrial users of oil. iii) alternatives. Not just the tree-hugging types, but coal-to-gas projects etc (coal is also in structural oversupply). Put all those together and it's hard to see a demand led reason why oil prices recover from here.

Second, is a lack of interest in company dividends. The problem is, a huge amount of this sector is owned by equity income funds, and if the dividends are cut then they become, at worst, forced sellers. Diividend sustainability should be a key part of the analysis.

Putting that together, and imagining oil staying below $50, then you want the strongest balance sheets, growth is irrelevant. Those names (in Europe at least) are Repsol, BP, Shell and Total.

Thanks for the reply Jack and sharing your insights. You have made a compelling argument for sustained low oil prices there and it seems difficult to disagree with your logic with my limited knowledge of this sector. I therefore agree that strong balance sheets should be paramount when thinking about potential investments going forward and if there happens to be an irrational over-reaction in oil prices causing them to spike up again in the near future then that'll be a a bonus.

Would you agree that perhaps drilling + E&P companies are likely to be the hardest hit therefore looking at the strongest companies in this area might be best?

 

[Jack o'Clubs]

Shell reports tomorrow so worth reading their statement very closely, particularly on outlook. Capex has a lot of room to be cut at the majors, the oil services company have already suffered the first round of this but I think there's a lot more to come. You're right that upstream is where strength will be most rewarded, likely cost of production is also a factor (ie onshore E&P more viable at these oil prices than deep water offshore). I saw reference to a Wood Mackenzie report today (industry gurus) which said something like $40 being the floor on the price because that's the level at which sufficient production is loss making at a cash level to rebalance demand/supply.

 

[SlowlyButSurely]

2 stocks I'm watching at the moment linked to Oil which I believe represent good value based on historic performance:

BHP Billiton (BLT LN)
Glencore (GLEN LN)

 

[mpi2008]

Shell reports tomorrow so worth reading their statement very closely, particularly on outlook. Capex has a lot of room to be cut at the majors, the oil services company have already suffered the first round of this but I think there's a lot more to come. You're right that upstream is where strength will be most rewarded, likely cost of production is also a factor (ie onshore E&P more viable at these oil prices than deep water offshore). I saw reference to a Wood Mackenzie report today (industry gurus) which said something like $40 being the floor on the price because that's the level at which sufficient production is loss making at a cash level to rebalance demand/supply.

Thanks Jack, that is useful info. If oil prices reach $40 and stay there for long then you would therefore imagine the industry would either have to buckle and reshape or OPEC +/- others would have to step in and turn off the taps. I'm not looking to find a bottom though, just invest at firesale prices in good companies.

RDS has taken a little tumble today and CVX and HAL now starting to look relatively cheap. Meanwhile, I've come across a few more stocks that have been hailed as financially 'solid' with plenty of upside (not necessarily by gurus though) which include Helmerich & Payne (HP) and REX American Resources Corporation. I like to find share price graphs that were hitting new highs during July/August '14 and seem to have been mainly 'knocked' off their pedestals by falling oil prices rather than intrinsic problems though obviously it is low oil prices that often expose too much leverage/debt for the first time.

 

[mpi2008]

2 stocks I'm watching at the moment linked to Oil which I believe represent good value based on historic performance:

BHP Billiton (BLT LN)
Glencore (GLEN LN)

Thanks, I'll take a look at these though on first inspection of their share price charts, I'm not blown away. Hopefully the balance sheets will impress a little more!

 

[TWI]

Not having a strong view on specific energy stocks I strated to scale into an energy ETF, VDE. Supply will almost certinly start to tighten within a year and although doubt we see prices move up dramatically, they are equally unlikely to remain sub $50.

 

[mpi2008]

Not having a strong view on specific energy stocks I strated to scale into an energy ETF, VDE. Supply will almost certinly start to tighten within a year and although doubt we see prices move up dramatically, they are equally unlikely to remain sub $50.

Yes I also looked at oil/energy ETFs but as they are based on futures contracts - which are frequently rolled over and subject to contango drag - I felt the ETF expenses and lack of oil price correlation were just too unsatisfactory. Ulitmately though, I realised it was hard to achieve satisfactory correlations no matter what method is used to try and invest in oil unless someone tries to 'time' the market with a spread-bet or direct futures contract; neither of which allow a long-term position to be built up in oil whilst the sector is depressed.

 

[mpi2008]

Not having a strong view on specific energy stocks I strated to scale into an energy ETF, VDE. Supply will almost certinly start to tighten within a year and although doubt we see prices move up dramatically, they are equally unlikely to remain sub $50.

Hi TWI, I have looked further into VDE (I actually already invest in one of Vanguard's lifestrategy funds) and I now realise I was mistaken and that it isn't based on oil price futures. It therefore presents a very attractive way to play the energy sector and I thank you for this comment. Another couple of energy ETFs are mentioned alongside VDE in the following article as excellent ways to handle the current uncertainty in the energy/oil sector:

http://www.hedgewise.com/blog/inves...l-long-term-avoid-contango-tracking-costs.php

 

[TWI]

Contango and ETF

Hi TWI, I have looked further into VDE (I actually already invest in one of Vanguard's lifestrategy funds) and I now realise I was mistaken and that it isn't based on oil price futures. It therefore presents a very attractive way to play the energy sector and I thank you for this comment. Another couple of energy ETFs are mentioned alongside VDE in the following article as excellent ways to handle the current uncertainty in the energy/oil sector:

http://www.hedgewise.com/blog/inves...l-long-term-avoid-contango-tracking-costs.php

Thanks. I agree completely on the drawback of investing in a contango futures related etf, on to a loser there before you start. Only people profiting from that contango are physical players with cheap stock financing who store product and sell forward, I worked with a 3 man team some years ago who made $100m doing just this while I struggled trading financials.
Right now I see a few people either starting to accumulate or looking for the best way to find some energy exposure. The opinion is definitely polarised between broad sector exposure vs. just the majors who you know will likely still be there inyears to come. Without clear insight into the businessmodel of the smaller dynamic players I will not be trying to stock pick there which is why these cross sector ETF's appeal but as you show, there is choice here too and hard to know which will pan out most favourably.

 

[mpi2008]

Thanks. I agree completely on the drawback of investing in a contango futures related etf, on to a loser there before you start. Only people profiting from that contango are physical players with cheap stock financing who store product and sell forward, I worked with a 3 man team some years ago who made $100m doing just this while I struggled trading financials.
Right now I see a few people either starting to accumulate or looking for the best way to find some energy exposure. The opinion is definitely polarised between broad sector exposure vs. just the majors who you know will likely still be there inyears to come. Without clear insight into the businessmodel of the smaller dynamic players I will not be trying to stock pick there which is why these cross sector ETF's appeal but as you show, there is choice here too and hard to know which will pan out most favourably.

In addition to VDE, have just come across PSCE (Powershares S&P Small Cap Energy) ETF. It looks to be down almost 50% in the past 6-7 months so also looking at this as a possible candidate for perhaps 30% of the investment but will probably dripfeed it in over the coming months (for both VDE and PSCE). Tempted to try a higher % on PSCE but also worried about a cascade of bankruptcies in smaller caps if the oil price stays low for a while......however on the assumption small caps will still be around in 4-5 years, I guess this would just provide cheaper prices for further buying.

 

[TWI]

Well, I have a little more VDE, also started taking a little long RSX, it is more broad sector but Russia is I guess an oil related play too. Time will tell and I do not expect to turf either of these out any time soon, unless there is a very dramatic geopolitical, financial or technological change that I do not see today.