Evaluating the Oil Market
The oil market can be a confusing and challenging place to understand for both professional investors and amateur stock pickers. Having a financial stake in the oil industry can be a harrowing experience for all investors, especially those with little experience handling the significant price fluctuations that can sometimes occur on a daily basis. Since oil is one of the main driving forces of a growing economy, it can be a valuable part of any diversified stock portfolio. Oil companies have historically found themselves near the top of the list of the world’s most valuable businesses. However, plunging oil prices have led some financial planners to question whether there is any future left for investors to take advantage of the once lucrative oil and gas industry.
How to Invest in Oil
There are numerous methods that an investor can choose to invest in the oil and gas industry. However, none of these involve driving to the gas pump and filling up containers with gasoline to sell to your friends or neighbors when oil prices go up. The best ways for an investor to make an investment in the oil industry would be to buy stock in an oil and gas company, trade oil options and futures, purchase shares in an energy-focused exchange-traded fund or mutual fund, or buy into a master limited partnership. Given the wide variety of methods to make an investment in the oil and gas industry, the average investor should stick to consulting with a certified financial planner prior to making any major investment decisions. Nevertheless, even certified financial planners are often confronted by challenges when attempting to invest in the oil and gas industry.
As the price of oil collapsed between 2014 and 2016, many investors jumped in on new investments in the oil industry, thinking that a price rebound would surely create a return on any initial investment. However, despite the fact that a relatively small rebound in oil prices was seen in 2018, oil prices crashed again in 2019 and 2020. Although, when looking at historical stock market returns and the performance of the global economy in general, oil and gas investments have traditionally offered investors a useful tool to increase portfolio diversification. When gas prices rise, the economy tends to stumble. When an economy slows down, other stock market investments may decline. However, when oil prices rise, stocks tied to the oil and gas industry also tend to rise. Investments in oil and gas can shield an investor from economic slowdowns initiated by rapid oil price shocks, similar to what was experienced during the 1973 Arab oil embargo.
The oil shocks of the 1970s crippled a significant portion of the global economy. Although, those who held investments in the oil and gas industry may have experienced a significant rise in income when compared to others with no exposure at all to the oil industry. Some investments in limited partnerships and smaller companies payed off significantly when drillers struck oil. A single oil well has the ability to generate may times the cost of drilling the well if oil is found. Moreover, oil and gas stocks are especially known for their ability to deliver hefty dividends over the course of many years.
One of the well-known disadvantages of investing in the oil and gas industry is price volatility. While the oil shocks of the 1970s led to positive cash flows for fossil fuel companies, wild price swings can take a toll on the average investor. Investing in small oil and gas companies, especially those that are involved in exploratory drilling, can commonly result in losses of 50 percent or more of originally invested capital. It is not unusual for these companies to also sometimes file for bankruptcy, which could result in a loss of all an investor’s funds. Since the oil and gas industry has been a notoriously volatile sector, it’s important to have a healthy grasp about the risks involved in these types of investments.
Historical Oil Price Volatility
Over the past few decades, the oil and gas industry has experienced a significant number of boom and bust periods. When looking at an interactive chart displaying West Texas Intermediate crude oil prices, it’s visibly dramatic to see the wild roller coaster-like spikes and drops in the price of oil since 1970. In July of 1973, the price of oil in today’s inflation-adjusted dollars stood at just over $20 a barrel. By February 1974, oil prices skyrocketed to over $55 a barrel. While at the time, many economists thought this would be the peak in oil prices, they doubled again to over $120 a barrel by June of 1980. Six years later, they collapsed to about $30 a barrel. By November of 1998, oil prices had crashed yet again to under $18 a barrel. Ten years later, prices shot up to the highest level in history, at over $150 a barrel in today’s inflation-adjusted dollars. Then, in December 2008, prices collapsed once again to $54 a barrel.
While briefly jumping back up to $130 a barrel by April of 2011, prices collapsed once more to just over $36 a barrel during the height of the oil supply glut in February of 2016. After a brief rebound to $76 a barrel in June 2018, prices plummeted again on concerns related to excess supply and weak global demand. This dizzying array of bouncing oil prices is indicative of what it sometimes feels like to be an oil and gas investor.
The Significance of 2019
In 2019, a dramatic shift in American strategic interests in the Middle East coupled with an exploding export market, a rapidly falling oil rig count, and range-bound oil prices made for one of the most consequential years in the fossil fuel industry. Robust demand from the global transportation industry and technological advancements in oil and gas exploration infrastructure led to a short-lived recovery for fossil fuel prices and production activities in 2019 (PR Newswire, 2019).
Growth in the U.S. oil and gas market was driven by a series of rapid transformations in the oil and gas industry. Expectations related to future energy demand were met by an increase in production levels, especially from American oil and gas companies. During this time, economists expected that global oil demand would increase by 104 million barrels per day by 2025, while natural gas use was also expected to continue to expand as coal-fired power plants continued to be taken offline (PR Newswire, 2019).
In 2019, the future of oil and gas production was expected to be shaped by factors such as population growth, economic expansion, and regulations related to vehicular fuel economy. In recent years, government policies had also helped to support more oil and gas industry exploration and production. While politics and economic growth have long been known as factors that could influence the oil and gas industry, few industry leaders expected to see the historic collapse in oil prices the took place in early 2020 as a result of the impacts from the coronavirus pandemic and the fight between OPEC and Russia over long-term global oil supremacy.
An Investment Opportunity?
As oil prices collapsed towards $20 a barrel in March 2020, some energy analysts and investors issued calls to initiate new investments in the oil industry given the fall to near record lows. As the news continued to get worse about the economy and oil price war, oil and gas companies became enthralled in a downward spiral towards dangerous levels of debt and unprofitability. As cash flows diminished and oil and gas stocks crumbled, some wondered whether initiating a long-term investment in the industry would be a prudent decision.
The pain experienced by the oil industry in 2020 has been unlike anything experienced in modern history. The weeks-long oil market sell-off in reaction to the coronavirus and the oil price war between Russia and OPEC created widespread panic throughout the energy industry. However, when looking into the future, it’s clear that the oil and gas industry will undoubtedly experience a recovery. While the exact timeframe for a broad market recovery is highly speculative, many investors have looked at historical prices to make a decision about current investments.
Looking to the Past
When evaluating historical crude oil prices, the trendline has collapsed and subsequently skyrocketed numerous times since 1970. It’s evident that 2020 will be recognized as one of the worst years for the oil and gas industry. However, as was experienced with other historic price collapses, the oil market has always bounced back. While investors should be cautious about jumping in too much and too quickly, an investment when the oil market is low may undeniably pay off with a long-term time horizon.
Throughout every historical collapse in oil prices, investors eventually come out and begin scooping up deals on oil and gas stocks. When investors start buying again, prices revert from their downward trajectory. In economic markets, the past can often be used to predict the future. Low oil prices and low interest rates have historically been catalysts for powerful bull markets. In early 2020, oil prices and interest rates collapsed in unison. Does this mean that another bull market is on the horizon? While it’s practically impossible to predict the duration of an economic downturn, markets have always rebounded in the past, with varying levels and speed of recovery.
Warren Buffet’s Bet on Oil
When questions arise about investing, people often turn to legendary investor Warren Buffet. As someone who stresses the importance of maintaining a long-term vision for investing, Warren has adamantly rejected the idea of buying and selling stocks based on short-term news headlines. With his long-term strategy at play, Warren made a massive investment in the fossil fuel industry in 2019, as oil prices continued to struggle to make progress. His company, Berkshire Hathaway, made a $10 billion investment in the Occidental Petroleum oil company (Frankel, 2019). This represents that largest investment made by Berkshire Hathaway in years and shows that even Warren Buffet has some faith that the oil market will experience a rebound in prices.
Despite the steep loses experienced in the oil market during the past few years, the oil and gas industry has a significant upside potential for investors. The oil prices that were experienced during the first few months of 2020 are truly unsustainable for the oil industry as a whole. Therefore, OPEC will eventually be forced to take action to stabilize prices in the form of production cuts. When paired with a growing economy, oil production cuts have historically boosted crude prices. While the damage that the industry has experienced during the beginning of 2020 has been unprecedented, these incidents have also created an attractive investment opportunity for long-term investors.
Overall, the oil industry is bound to recover from the disastrous events that took place related to the coronavirus, the oil price war between Russia and OPEC, and the global supply glut. As the economy recovers, oil prices would also be expected to make a comeback. For investors looking to capitalize on future oil market strength, the time to invest is when prices are low. While some energy analysts have suggested that the oil industry may continue to spiral downward due to the increasing market share captured by new renewable energy projects, the International Energy Agency still has maintained projections that show how oil and gas consumption will continue to grow in the next decade. While it’s clear that renewable energy may dominate the energy industry over the course of the next 50 years, the world will still need more oil in the near future.
Daltorio, T. (2020). “How to Invest in Oil.” Investopedia.
Frankel, M. (2019). “Warren Buffett’s $10 Billion Oil Investment: What You Need to Know.” The Motley Fool.
Navin, J. (2020). “The Price of Oil and The Price of Oil Stocks: New Lows.” Forbes
PR Newswire. (2019). “United States Oil and Gas Market, Size, Share, Outlook and Growth Opportunities 2020-2026.” LNG Analysis.