Please ensure Javascript is enabled for purposes of website accessibility

Forget Buying USO Stock: Buy This Oil Stock Instead

By Matthew DiLallo – Apr 26, 2020 at 2:11PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Speculating on oil prices through this ETF isn't the best way to profit from a potential oil market rebound.

Oil prices have gone berserk in the past week. The May contract for West Texas Intermediate, which is the main oil price benchmark, plunged into negative territory on Monday. Like a game of musical chairs, oil price speculators were in a mad dash to unload oil futures contracts before they expired and had to take physical delivery of the oil. With storage space running out, they needed to pay a high price to exit these failed bets that oil would rebound.  

Oil would rally from that bottom as speculators placed new wagers that the industry would solve its looming storage crisis with additional production cuts. One way some traders are gambling on that recovery is through oil price ETFs like the U.S. Oil Fund (USO -5.29%). However, they're playing a dangerous game, since that vehicle could go bust if oil futures crater again.

With that and the oil ETF's other issues in mind, investors should avoid using it as a means to profit from a potential oil market recovery. Instead, a better bet would be to buy a top-notch oil producer like ConocoPhillips (COP -8.60%). Here's why it's a better option than the U.S. Oil Fund.

An oil drilling rig with the sun setting in the background.

Image source: Getty Images.

The financial strength to survive this downturn

Shares of USO have cratered this year because of all the volatility in the oil market. The fund has had to take several steps to stay afloat, including issuing all its remaining shares, approving a reverse-stock split, and planning to roll more of its contracts further into the future to avoid another implosion at the June expiration. However, it's possible that these moves might not be enough and that the fund might need to liquidate. That's what happened to the iPath Series B S&P GSCI Crude Oil Total Return Index ETN, which suspended new sales this week and will liquidate at the end of the month. If that happens to USO, it won't be around for a potential future oil price rally, which means holders will lose out on an opportunity to participate in that rebound.  

ConocoPhillips, on the other hand, has one of the strongest financial positions in the oil sector. The energy company ended last year with $5.4 billion of cash on its balance sheet and another $3 billion in short-term investments. It also has one of the lowest leverage ratios in the oil sector. Meanwhile, it has quickly reacted to crashing crude oil prices by adjusting its operating plan. Overall, it has slashed its costs by $5 billion this year, which will help preserve its strong cash position. That enhances its ability to survive the oil market downturn so it can prosper when oil prices improve. 

Lots of upside to higher oil prices

Whereas USO holds oil futures contracts that expire in the coming months, ConocoPhillips controls physical oil. That provides it with more flexibilit,y as it can leave this crude underground and wait until prices improve. It's currently taking advantage of that optionality by curtailing 225,000 barrels of oil production per day over the coming months, saving it for higher prices. 

ConocoPhillips also controls an enormous amount of low-cost oil reserves. It ended last year with 15 billion barrels of oil equivalent resources with supply costs of less than $40 a barrel, roughly two-thirds of which it could produce at prices below $30 a barrel. That low-cost supply base not only enables ConocoPhillips to make some money as it produces crude at lower prices but also positions the company to cash in when they rebound. It can generate a gusher of excess cash at higher prices, giving it the money to return to shareholders via dividends and share repurchases.

USO, on the other hand, tends to see its value erode even when oil prices rebound, because of the costs of rolling its futures contracts. It often underperforms the price of oil as a result. Contrast that with ConocoPhillips' leverage to oil, which often enables it to outperform crude pricing during a market rebound:

USO Chart

USO data by YCharts

Don't choose the wrong vehicle to play your oil hunch

The implosion of the oil market this year has investors starting to look out into the future at an eventual recovery. While it seems likely that oil prices could rebound in the future, USO isn't the way to play that thesis. Instead of buying a risky ETF that might not survive this oil price downturn, it makes more sense to invest in an oil company that has not only the strength to endure but also lots of upside to higher prices.

Matthew DiLallo owns shares of ConocoPhillips. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

ConocoPhillips Stock Quote
ConocoPhillips
COP
$100.59 (-8.60%) $-9.47
United States Oil Fund LP Stock Quote
United States Oil Fund LP
USO
$65.32 (-5.29%) $-3.65

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
329%
 
S&P 500 Returns
106%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/24/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.