Oil price has crashed from high $100’s reached since 2007 to mid $40 and $50s. Following the bottoming in the prices and its recovery. The pendulum between risk and reward looks to be leaning towards reward for long term investors.
On a sector basis, investors can play in the recovery oil prices either directly with oil commodity ETFs or energy stock ETF. There are a number of reasons we are leaning towards investing in energy companies rather than oil as a commodity it self.
Only the largest energy companies with bullet proof balance sheet will survive the current down turn. Shale producers that has leveraged balance sheets are still drilling to maintain cashflow but not in creating value for their shareholders. This is because while current oil production are “positive” on a cash cost basis for shale producers. On a total aggregate cost of producing a barrels of oil which includes depreciation of capex, interest and administration cost. The Shale producers simply cannot compete at these prices.
Oil Stock ETF Performance
We are leaning towards large cap energy companies which has the wherewithal to withstand the downturn and a margin of safety. The questions for large cap energy company is not if they survive or not but the earning impact of low oil prices. Strong oil prices will have implications on the US dollar.
From the production side, there is only so long the current level of oil production will begin the taper. Aggregate production has not matched the decline in operational rig count in the sector. This will flow through in the next 6 month as the horizontal rigs has short shelve life and to maintain current production require continue drilling which is not happening.
Fall in medium term production is expected and it will be supportive of oil prices in the near term. We feel the bounce in oil prices this year is sustainable. It is simply a matter of time before the shale producers run out of financing and cash. Investors in anticipation of the recovery will be paid by taking the risk today in energy company stocks.
Related: Read our selection of Energy ETFs
Once the oil market has stabilised then the focus for companies will shift back to growth. Growth either through increasing production competitively and also swallowing up the weaker players that are no long competitive to get ready for the next up cycle in oil price.
On a seasonal basis, the US driving season is ramping up which would impact gasoline price. The upswing in seasonal demand would further support current recovery in oil prices.