Yesterday, we saw a historic reshuffling of the Dow Jones Industrial Average.
Surprisingly, Exxon Mobil, the world’s largest company in 2013, got kicked out of the index.
Exxon was the longest-tenured member, having been part of the Dow Jones since 1928.
While this move came as a shock, it’s a clear sign of how out of favor oil stocks have become in recent years.
But despite this negative trend, many are not willing to write this sector off. I’m one of them. After all, our society cannot exist without oil.
And with stock prices near record lows, it’s becoming hard to resist the attractive valuations.
Let’s weigh the pros and cons, and see if now is the time to invest in this sector.
Rising Supply, Falling Demand, And The 2020 Oil Market Collapse
Let’s start with the negatives since that was the main driver of oil prices lately.
After the most recent peak in October 2018, the global economy began slowing down. This meant lower demand for industrial commodities, which includes oil. Economics 101 teaches us that lower demand equals lower prices.
At the same time, supply never decreased to offset a drop in demand. In fact, the world’s largest producer—the United States—was even increasing it. Again, economics 101 teaches that higher supply results in lower prices.
This increasing-supply-falling-demand dynamic was forcing the prices ever lower until reaching its apex in the Spring of 2020.
Because of the worldwide shutdowns in response to the Covid-19 pandemic, oil demand fell to multi-decade lows. At the same time, OPEC and Russia, the other two major oil suppliers besides the United States, started a dispute over production levels with neither willing to budge. Meaning, supply stayed at pre-crisis levels much longer than it was reasonable.
This crisis resulted in the oil market crash, which saw the commodity’s futures price collapse to -$38. With storage facilities filled to the brim and little to no demand, there was simply nowhere to offload all the supply.
Since then, the supply and demand picture has improved, something I will touch on shortly.
But before I do, I would like to bring to your attention another long-term negative trend that has been weighing heavy on oil stocks.
It’s the rise of green energy.
Oil, as we know, is a major pollutant. This has caused many governments to focus their spending on renewable energy sources, and increasing regulation on carbon emitters such as oil.
This is a long-term trend that nothing can stop.
Furthermore, in recent years, it has become one of the primary election messages for politicians looking to sway voters to their side.
This led to plenty of negative press for oil stocks and is a major reason why investors have been shying away from them.
Oil Prices Forecast Improving
Despite the negative trend in oil prices over the last two years, at some point, it has to end.
As I mentioned in the beginning, our society still needs oil to function, so it can’t go to zero.
The big question is whether we have reached that point in 2020?
The supply and demand dynamic indicate that is so. Over the last few months, it has made a complete turnaround.
After we saw demand fell to multi-decade lows during the lockdown, it started recovering.
Sure, it will be years before it reaches pre-crisis levels, but it is nonetheless on the rise. Economics 101 teaches that rising demand leads to higher prices.
Likewise, the supply is decreasing. Russia and OPEC countries have agreed on the production cuts, and are more or less sticking to them.
At the same time, the oil collapse has made many American shale operators go bust, or at the very least, forced to decrease their operations significantly.
This means that the global supply is declining. Once more, economics 101 tells us that decreasing supply equals rising prices.
Meaning, the only significant downward pressure remaining is the green energy narrative.
As I mentioned earlier, this is a trend that cannot, will not, and shouldn’t be stopped. Carbon dioxide pollution is real, and we must do something about it.
But is this force alone enough to keep the prices where they are, or will the decreasing supply and rising demand prevail in pushing oil higher?
Well, that’s the million-dollar question right now.
Verdict And My Recommendation
When I look at the long-term picture, my opinion is that we have entered a world of permanently low oil prices.
I see it hovering in the $40-$60 per barrel range, with occasional swings above or below those levels.
That said, I also believe that oil stocks are undervalued at this point. While oil prices have recovered in recent months, the same can’t be said for oil stocks. There is simply too much negativity surrounding them. But, as I mentioned earlier, that sentiment is changing for the better.
If you’re considering investing in this sector, I would suggest you consider the oil majors. They’re all well-capitalized, so they can survive if oil prices stay lower for longer. Moreover, this allows them to keep paying their dividends.
One you can opt for is the aforementioned ExxonMobil. Given that it offers a safe and secure dividend yield of 8.5%, there is little risk involved in owning this stock for the long-term.
Good investing,
Leon Wilfan
