Many investors look to oil stocks for dividend payouts and view these stocks as conservative investments. It is important to understand what moves these stocks and what that can mean for your portfolio. Oil stock performance is highly correlated with the price of oil. Oil itself is a commodity that is subject to complex, and often sudden external forces. For instance, in the 19 months from June 2014 to January 2016, the price of oil dropped 75%. Major oil stocks lost about 30% of their value while the S&P 500 only dropped 8%. The forces behind that price movement have changed the dynamics in the oil market forever. We will dive into these dynamics further later in this post.
Oil companies around the globe are adjusting to a new normal in a price environment that experts have called “lower for longer”. Many companies, especially large US operators, have survived the downturn and regained sales and profitability. However, the stock market has not rewarded them. Given the lower correlation to the stock market generally (e.g. stock prices that move as oil moves, and less along the lines of the general market), these stocks add value in diversifying a portfolio. That said, investors should also consider other traditional conservative sectors like consumer staples and defense to build a properly rounded portfolio. Catamount has representatives from each of these sectors in our portfolio.
OPEC gives way to US producers
Let’s start with a bit of history to give better context for the most recent changes in the market. Since the mid-1960s, OPEC, an organization of oil producing states, has tried to bring calm to the oil markets by regulating the production of its members. It maintained this power because it was comprised of the global “swing producers”. These countries could effectively turn the tap “on” or “off” at their convenience. While this arrangement has been disturbed by geopolitical disputes from time to time, most spare oil production capacity remained in OPEC’s control.
However, technological advances in areas like “fracking” and relaxed environmental policies enabled the United States to nearly double oil production from 2008 to 2015. In effect, the US became the swing producer for oil. This growth in production led to a glut of oil in the marketplace. As a result, prices plummeted. Instead of cutting production, OPEC allowed the glut to continue to drive higher-cost producers in the US out of business. This strategy worked to some extent, with around 100 US-based oil and gas companies going bankrupt. However, most all major US producers emerged leaner and lower-cost than ever.
Fast forward to today. Over the last year, oil prices have been bouncing around between $45 and $55 per barrel, without breaking out in either direction. In that same time, the largest US independent oil producers have turned earnings from negative to positive, and about doubled revenues. Despite incredibly positive fundamental rebound, and general upswing in equity markets, only a few have outperformed the S&P 500.
What does the future hold for oil?
Looking to the future, even the Middle Eastern oil titans appear to have a bearish sentiment. The man who founded modern day Dubai once said, “My grandfather rode a camel, my father rode a camel, I drive a Mercedes, my son drives a Land Rover, his son will drive a Land Rover, but his son will ride a camel.” That man’s name was Rashid bin Saeed Al Maktoum. This quote reflects a commonly held view that even though oil can bring about tremendous wealth, that wealth will only last a few generations. Dubai has actively sought to diversify its economy away from oil and has become an economic powerhouse by investing oil dollars in trading infrastructure. Saudi Aramco, the state-owned oil company of Saudi Arabia that also represents the largest oil company on the planet, has announced plans to IPO and plans to diversify away from oil starting in 2018. You can see similar public diversification plans announced recently in Egypt, Qatar, UAE, and Oman.
Electric cars are a strong headwind here as well. While not all of oil goes into fuel (some goes into plastics and other chemical products), a good portion of it does. In the US, about two thirds of the petroleum products consumed are in the form of fuels that could be replaced by electric vehicles. Goldman Sachs predicted that by 2025, 25% of cars will have electric engines. Major car producers around the world are moving towards electric vehicles. Whether it is the all-electric Tesla models in the US, or Volvo vowing to make non-petroleum cars by 2019, the future is looking dimmer for oil. Additionally, Britain recently vowed to ban diesel and petroleum cars by 2040.
How does this fit into Catamount’s strategy?
In summary, there are strong headwinds in the long term for oil. While oil stocks can be valuable in a portfolio from a diversification and dividend perspective, it is important to look at other sectors that can also add these characteristics to your portfolio. At Catamount, we have some exposure to oil, but also to other conservative, dividend paying stocks like those in consumer staples and defense. Considering the challenges facing oil and gas going forward, we are also closely monitoring new energy technologies like renewables, energy efficiency, and energy storage. More to come on these sectors…