There's a saying on Wall Street that you should buy when there's blood in the streets, which pretty much describes the situation in the energy patch today. The sector is deeply out of favor because of a massive supply/demand imbalance and a long-term global shift toward cleaner alternatives. So why would you want to own oil and natural gas stocks? Here are four reasons.
1. Oil isn't dead
There are very clear problems in the energy sector today. The most immediate is that oil and natural gas prices are so low that it's hard for drillers to make money. In fact, at one point in early 2020 a key U.S. oil benchmark briefly fell below zero. While prices have improved, they remain historically low. The economic shutdowns used to slow the early spread of the coronavirus and a long-term shift toward cleaner alternatives are both factors.
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However, oil and natural gas remain key players of the global energy pie. There's a huge infrastructure that supports them, and they won't be easily displaced. ExxonMobil (XOM 0.39%) expects the transition away from these carbon fuels to take decades -- after all, it took 100 years for oil to displace coal as the world's top energy source. In fact, even in some of the most aggressive estimates for clean energy adoption, oil will still remain important for years.
That pairs with an important aspect of energy drilling: Wells eventually run dry. So even in a world that's using less oil, companies will have to keep exploring and developing new resources. In fact, at current investment levels, Exxon believes the world won't have enough oil and natural gas. If that's the case, the supply/demand imbalance that is muting prices today will ease and energy prices could rally. Oil and gas stock will also rally if that happens.
2. The transition
That's good, but there's another reason to be excited about the energy patch: natural gas. This fuel is cleaner-burning than oil and is often used to generate electricity. Electricity is expected to be one of the more important energy sources in the near future. Part of the reason for that is that natural gas-powered electricity plants, which can be turned on and off relatively quickly, pair nicely with intermittent renewable power sources like solar and wind. That helps ensure a constant flow of power throughout the day. So even as oil demand starts to slow, natural gas demand is expected to keep rising.
Notably, this is a key piece of Total's (TTE 0.52%) business plan. Not only is it building an electricity business, but it's shifting its drilling efforts toward natural gas. The goal is to help support the world's move away from oil while building in some internal hedges for its increasingly important "electrons" business, which it believes will make up 15% of sales in 2030, up from 5% in 2019. Natural gas, meanwhile, is projected to be about 50% of sales, up from 40%. Oil should fall from 55% to 35%. The key takeaway, however, is that natural gas could end up being a growth business even if oil continues to decline.
3. Valuation
When Wall Street sours on an industry, it often throws the baby out with the bathwater. That appears to be the case in the energy patch. While there is a lot of pain today, with many once-proud names falling into bankruptcy, larger and well financed companies are going to muddle through. Most of the integrated energy giants are likely to be survivors. But the stocks have been brutally punished.
Even the best performing name, Total, has lost roughly a third of its value so far in 2020. The worst performer, Royal Dutch Shell, is off by around 50%. Yes, earnings are terrible, but most of the big international players have ample financial resources to survive this downturn like they have survived downturns before. And for more intrepid investors, they are very clearly on sale. Huge dividend yields point to the value here, with Exxon, Total, and Shell all offering high-single-digit yields that are toward the upper bounds of their historical yield ranges. Chevron's yield, which is in the mid-single digits, is also historically high. If you can stomach some uncertainty, the energy sector is worth a deep dive for value-oriented investors and those in search of big dividends.
4. Changing with the times
The last reason to consider energy stocks is that the industry is changing. While Exxon and Chevron have basically decided to stick with oil for now, they have some small clean energy projects in the works. For example, Exxon is looking at creating biofuels from algae that would allow it to keep using its current oil infrastructure well into the future.
That said, as noted above, Total is moving more deliberately. It is actively building a business around electricity and renewable power. But it isn't alone -- Shell and BP have both embarked on similar, if not more aggressive, plans. The goal of all three companies is to ensure they have a place after the world shifts away from carbon fuels. Basically, they see the writing on the wall, and are actively doing something about it. This is hardly an industry that's sticking its head in the ground and praying that things get better.
Not for everyone
There are clearly risks involved with buying an energy stock today. But when you look at how deeply out of favor the sector is and consider the four points above, the pain seems a bit overdone. You'll need a strong stomach, but if you can invest when others are fearful, you might want to add some oil to your portfolio today.
