Oil Stocks: No Thanks — Oil Stock Price Outlook
Today’s Daily Reckoning Australia turns its attention to the oil price.
Brent crude is trading around US$77 a barrel. There is a bullish narrative forming around the whole sector.
The Australian Financial Review ran an article last week headlined ‘Energy stock disconnect gets “crazy”’ and began with…
‘The share prices of Australia’s major oil and gas producers remain stubbornly subdued despite bullish commodity prices, leading to concerns that the sector is being unreasonably discounted on ESG grounds that have rocketed up the agenda for investors since the onset of COVID-19.’
I’ve been sceptical of the oil price for the entirety of this rally. I’m still the same way now.
But it can’t be denied that the price is defying this expectation.
Both my colleagues Greg Canavan and Murray Dawes are surfing this wave profitably already.
Perhaps I’m burnt by experience.
In 2018 I put a lot of work into oil and concluded that there were good odds of it going higher.
In October 2018 the oil price collapsed 40%. You might recall the US share market dived around this time too.
Part of my objection to seeing a sustained rise in oil from here is the notion that there’s not enough oil to go around.
Consider the strategic reserves that the US and China hold.
In the US this is known as the Strategic Petroleum Reserve (SPR). Last time I checked it had 638 million barrels.
Here’s an observation. The SPR is redundant. Most of these barrels could be sold into the market and the money put to use elsewhere.
A little history makes this clear. The SPR came into existence after the oil shocks 50 years ago.
The US didn’t want to be held hostage to the Middle Eastern producers whenever they felt like sticking it to the US.
US oil production was also declining at the time.
The world has long since moved on.
The US economy still uses a lot of oil — but the US now has ample domestic reserves and production that the shale fields can provide as needed.
And the bargaining power of OPEC is not what it was. In 1979 they had oil and the world had no choice but to play ball with them.
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Oil’s days are numbered now. Nobody knows the specific time frame on how numbered.
But a high oil price merely speeds the urgency of the transition away from fossil fuels and makes renewables more competitive.
The Middle Easterners must also know that they have no guarantee now that any oil in their fields will leave the ground and turn into cash.
They have every incentive to pump every barrel they can to monetise it. Future production may never come.
And so, we come back to the oil stocks.
Some of them have very good cash flows, no doubt. But it’s unlikely they’ll ever carry much growth premium.
What do I mean? Most stocks trade on a multiple of 10–15 times earnings.
But there’s no guarantees here either.
It’s perfectly possible, depending on the vagaries of the market, for a stock to trade on a P/E of 1 or 2. You pay for cash flow and that’s what you get.
I’m not saying this will happen, only it’s a possibility.
It’s also likely some sort of carbon price or penalty is coming toward oil producers.
Perhaps this is what is suppressing their prices now — the market is discounting these charges.
I’m not sure. But I’m inclined to put oil shares in the too hard basket from all this.
The lord knows it’s hard enough to figure out whether the price is going up or down, let alone all the other variables (field flows, exploration, expenses, etc).
It’s not as if there aren’t opportunities elsewhere in the market.
However, I’m prepared to be surprised here. One analyst I follow from time to time suggests the Fed and US powers that be don’t mind a high oil price because they can blame the coming inflation on oil instead of their loose monetary policy.
Is this possible? Sure.
I remember a guy wrote a book, whose name I can’t remember now, saying that the US used the high oil price before 2008 to try and screw the Chinese (a heavy importer) at the time.
Geopolitics is a nasty business. I don’t know if either of the above points are valid. They are just opinions I’ve seen.
However, for me it all adds to the same thing: oil stocks belong in the too hard basket.
Editor, The Daily Reckoning Australia
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