After trading north of $90 since June 2012, the price of oil has crashed, falling more than 50% from its high this summer and dipping below $50 per barrel Monday.
Nearly every pundit out there is declaring low oil prices are here to stay. With the glut of oil being produced by OPEC and the U.S., the days of $90 oil are over, they claim.
But, always a contrarian, I suspect oil prices may surprise people and move higher in 2015, which is why I love the big integrated oil companies – and their dividends – right now.
What Will Push Oil Prices Higher
[ad#Google Adsense 336×280-IA]On the first day of Economics 101, you learn about supply and demand. When supply outstrips demand, prices fall.
And that’s exactly what is happening in the oil markets.
The United States and the OPEC countries are producing more oil than the world needs, particularly with Europe still struggling and China slowing down.
As a result, it’s tough to find any expert who believes prices are going higher or oil stocks are a good buy.
Here’s why I think they are wrong:
- Crises happen – In 1978 there was an oil glut. Then a revolution took place in Iran and the price of oil doubled. Considering that the Middle East isn’t exactly a model of stability and Vladimir Putin is likely to roll more tanks across the borders of former Soviet republics, there is a decent chance some crisis will occur that pushes oil higher.
- Free markets work– Rick Rule, founder and chairman of Sprott Global Resources Investments Ltd., has a great quote: “Markets always work; the cure for high prices are high prices, the cure for low prices are low prices, each is the author of the other.”In other words, when prices get out of whack, the market stabilizes. When prices are too high, demand falls off and prices decline. When prices are too low, demand increases and so does the price. Oxford Club Energy and Infrastructure Strategist David Fessler agrees. In his words: “Lower prices means more drillers will stop drilling. This will eventually cause the supply surplus to dry up. Remember, we’re only talking about 1 million to 2 million barrel per day surplus over demand. Once that happens, prices will do a quick U-turn. I think it’s going to happen in the next six months or less.”
- Being contrarian works – Contrarian investing is investing against the conventional wisdom. One reason it works is that the crowd is often wrong. But the other important reason is that when you are a contrarian, you are buying what everyone else is selling and selling what everyone else is buying.
Going back to our Econ 101 class, if everyone is selling a stock, that means you get to buy it cheap. And if the crowd is buying a stock, you sell it when prices are high.
What You Should Buy
The thing about contrarian investing is you sometimes have to be patient. The crowd usually isn’t proven wrong the week after you buy a stock. Contrarian themes can take months (or longer) to develop. At the same time, you don’t want to be in stocks that post huge losses while you wait for things to turn around.
For that reason, I’d avoid the smaller oil producers and services companies – particularly those with a lot of debt on their balance sheets. As companies receive less dollars for their oil and the oil companies spend less on services, the businesses with high debt levels may have a tough time servicing their debt, which could require a dilutive equity offering.
If they have to cut their dividends, the stock price will get hammered as we saw recently with Seadrill Ltd. (NYSE: SDRL) and Civeo (NYSE: CVEO). (For more on the Civeo story, check out my latest article for Wealthy Retirement.)
The big integrated oil companies appear much safer. Stocks such as Chevron (NYSE: CVX), Exxon Mobil (NYSE: XOM) and ConocoPhillips (NYSE: COP) have solid balance sheets and experienced management teams who are not going through this type of market for the first time.
Additionally, they pay solid dividends that can help investors stay patient while they wait for a turnaround in the oil market. Chevron and ConocoPhillips both pay over 4% yields. And all three of the companies I just mentioned trade at a price-to-earnings (P/E) ratio ranging from 9 to 11. Meanwhile the S&P 500 trades at over 18 times earnings.
These stocks are cheap, pay a healthy dividend yield and this is a great opportunity to buy low.
You can either follow the masses into the “oil is never going higher” camp or you can look at years of economic history and crowd psychology and decide, like me, that this huge sell-off presents us with a unique opportunity to buy low… and get paid to do it.
Good investing,
Marc
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Source: Investment U