Now is the time to buy oil stocks?

There are different levels in the oil industry that investors should pay special attention to. This is truer today than it has been for many years. If you are looking at oil stocks right now as the price of this energy commodity has skyrocketed, make sure you are entering the right sector of the market for your long term needs. To help you determine if it is a good time to buy oil stocks, you may find it helpful to review Centennial Resource Development (NASDAQ: CDEV), ConocoPhillips (NYSE: COP), and Chevron (NYSE: CVX).

The basic problem

Oil, as stated, is a commodity. This means that, for the most part, a barrel produced by one company is largely interchangeable with a barrel produced by another. Thus, the price is determined by supply and demand, the balance fluctuating here over time. The past two years are a telling example.

Image source: Getty Images.

In 2020, the coronavirus pandemic resulted in widespread economic shutdowns. This quickly reduced the demand for oil, causing prices to drop. As is common when prices fall, capital investment in the energy patch has also declined. In 2021, demand returned, along with the increase in economic activity. But due to the downturn in the entire energy sector, supply is lagging behind demand, and energy prices have reached all-time highs since 2018. The biggest news, however, is , is how quickly energy prices have skyrocketed, with Brent crude prices rising by about 75%. over the past year.

“Is it time to buy? “Vs” What do you want to own? “

This is extremely exciting and has led to a strong rally among energy stocks. But here’s where things get a little interesting. The small exploration and production name Centennial Resource Development, with a market cap of just $ 1.9 billion, has seen its shares rise about 880% in the past 12 months. It’s a massive rally by any stretch of the imagination. Shares of nearly $ 100 billion market-cap driller ConocoPhillips rose about 120%, while diversified industry giant Chevron, with a market cap of over $ 200 billion, saw its action earn “only” 50%.

The size distinctions here are important. Centennial is small and all about drilling, which means that fluctuations in the price of oil and natural gas can have a disproportionate effect on its bottom line. Its small size also means that it tends to rely heavily on leverage, often linked to its reserves (which change in value with the price of energy), to finance its activities. This means that commodity rallies can be extremely beneficial, while price drops can be particularly painful. Centennial is the kind of business you buy when you want to take advantage of fluctuating energy prices. After such a huge price gain over the past year for both stock and oil, investors now considering Centennial need to be very confident that oil and gas prices will continue to rise if they fall. launch into this action. This is a high leverage bet that most investors probably shouldn’t make.

COP table

COP data by YCharts

ConocoPhillips is sort of in the middle here, with enough scale that it can generally withstand the ups and downs in commodity prices while still having adequate access to capital markets. Thus, he can generally easily navigate troubled oil markets. This ability, which usually comes with less sensitivity to fluctuations in oil prices, is what focusing on a mid-range name in the energy sector offers investors. However, as with Centennial, after such a steep rise in the price of ConocoPhillips and the price of oil, investors must have a positive outlook for what is known as black gold if they buy this stock. Of course, a drop in oil wouldn’t hurt so much here, but it would still hurt.

Chevron belongs to the category of large integrated energy companies, which is essentially made up of the largest and most diverse names in the energy industry. Chevron’s activities extend to the drilling (upstream), power transmission (middle) and chemicals and refining (downstream) sectors. The ultimate goal is to smooth the performance of companies over time, since each of the sectors has a different revenue profile. While Chevron’s bottom line is still heavily dependent on oil prices, it’s generally a more predictable and consistent move – for example, the company has been increasing its dividend every year for more than three decades. Chevron did not fall as much when oil prices fell and did not rise as much as they recovered, with dividend investors continuing to receive a generous dividend throughout the process. The current yield, meanwhile, is historically high at nearly 4.9%. This is the type of stocks you buy when you want to invest for the long term. Even in today’s environment, this would be a great addition for income investors looking for energy exposure.

What to do with the oil?

Ultimately, the question of whether or not it’s time to buy oil stocks really comes down to a timing call. Energy commodities have experienced a strong recovery and, based on the supply / demand imbalance, they could continue to rise. However, eventually supply will catch up with demand and prices will fall again. This is how the industry works. After such massive ramp-ups, pure play drillers like the tiny Centennial and mid-range name ConocoPhillips probably don’t have much room to operate unless the oil keeps rising. That’s the bet you make with these two drilling-focused names. Chevron, meanwhile, still looks historically attractive based on its dividend yield, and should deliver a smoother ride regardless of the direction of oil prices due to its more diverse business model.

In other words, long-term investors looking to own an oil name should stick with Chevron today. Speculators will likely prefer Centennial or, for those with a lower tolerance for risk, ConocoPhillips. However, neither of these two drillers is a ‘set it and forget it’ headline, so you’ll need to watch carefully in case oil prices move against you.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

About Mallory Brown

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