Oil prices have been volatile in recent days because investors are worried that the omicron variant of the coronavirus will lead to widespread economic shutdowns. That could very well happen, but the big picture for energy stocks won't materially change even if it does. Here's why now could still be a good time to buy oil stocks and why you need to be cautious about which ones you choose.
Inherently volatile
Oil is a cyclical industry, with demand tending to ebb and flow along with economic activity. And since oil is basically a commodity, there's little energy companies can do to differentiate their products. Thus, the financial results in the industry tend to rise and fall along with the highly variable price of oil. It's just how the sector works. Notably, when demand fell sharply because of the economic shutdowns used to slow the spread of the coronavirus in 2020, energy companies suffered and so did their stocks. Although demand has come back, the new omicron variant has investors worried about shutdowns again. And, thus, oil and energy stock price volatility is high.
Image source: Getty Images.
But the long-term picture here hasn't changed. For starters, carbon fuels like oil are going to be losing share in the broader energy space to cleaner alternatives over the long term. However, for the next couple of decades, increasing global energy demand will likely offset that and lead to increased demand for oil and natural gas on an absolute basis. That suggests that still-strong demand for oil will continue for years, buttressing the businesses of the companies that produce it.
ExxonMobil (XOM -0.09%) CEO Darrin Woods summed this up recently during a company update, noting that, "Where there are no practical alternatives, people will continue to need the products we produce for decades to come. And so we'll continue to responsibly meet people's needs for energy, consumer products, and other advanced materials." But in that statement is the great divide that investors need to consider in the energy patch.
Backing the right horses
Exxon and U.S. peer Chevron (CVX 0.75%) have been relatively slow to address the clean energy transition that is taking place today. They basically see a long runway ahead for oil and are moving slowly to shift their businesses. Both are industry giants, with integrated business models that span from the upstream (drilling) to the downstream (refining and chemicals) spaces. For most investors, this inherently diversified approach to the industry is probably a better option than a pure-play driller, which will likely see performance rise and fall more dramatically with the price of oil. Indeed, if you believe that oil is still important, and will continue to be so, then Exxon and Chevron should be on your short list as relatively pure bets on the space.
Notably, both have historically high dividend yields backed by companies that have proven their commitment to supporting their dividends over several decades. It's also worth highlighting that these two industry giants also have very strong balance sheets, with debt-to-equity ratios near the low end of their integrated energy peer group. That gives them the flexibility needed to weather hard times and still keep paying their dividends.
Data by YCharts.
That said, it isn't exactly clear when the broader energy industry will tip toward clean energy and demand for carbon fuels will start to fall on an absolute basis. Exxon and Chevron, and those that invest in them, are betting that time is a long way off. Companies like BP (BP -1.17%), Shell (RDS.B), and TotalEnergies (TTE -1.28%) are taking a slightly different approach. They are all working now to build clean energy businesses using the cash flows from their oil and gas operations to fund the needed investments. It's sort of a middle ground approach that lets investors own oil stocks with a clean energy safety valve, if you will.
There are still important differences here. For example, BP's balance sheet is highly leveraged relative to peers. That helps explain why it cut its dividend to help fund its effort to invest more aggressively in clean energy. Most investors will probably want to avoid BP given the other alternatives in the integrated energy space.
This brings up Shell and TotalEnergies. Shell also cut its dividend as it reset its business priorities to include clean energy. However, it has gotten right back on the dividend growth path, with three dividend increases since it cut at the start of 2020. The company's yield is low relative to peers, but it is probably the best positioned to offer slow and steady dividend growth while it shifts with the world around it.
Data by YCharts.
TotalEnergies' stance has been to support its dividend through the same type of transition. That, however, means that the high relative yield here probably won't be accompanied by regular dividend increases. So investors are trading off a high current yield for less dividend growth. Still, if you are looking to maximize the income you generate, that might be perfectly fine with you.
Time to buy oil?
As with so many things in investing, the buy or don't buy answer in the oil space today is: It depends. The industry will likely benefit from strong demand for years to come, so there's no reason to avoid it, per se. Thus, the omicron variant fears could be a buying opportunity. That said, for most investors, it makes more sense to stick with the largest names in the space, which are the integrated energy giants highlighted above. But within this group, there are different stories. Exxon and Chevron are basically the pure plays, intending to stick as long as possible to their oil focus. BP, Shell, and TotalEnergies are starting the shift toward clean energy, but are traversing different paths. BP's leverage is a worry, Shell cut its dividend but is growing it again, and TotalEnergies is trying to balance the energy transition while supporting its current payout.
While all of this means there's a lot of variation to consider here, it also means that you'll probably be able to find an oil name that suits your needs well.
