Oil is aptly called black gold, considering the billions of dollars in profits it has generated for oil companies over the past several decades. With crude oil prices hovering above $95 per barrel, investors are wondering if oil and gas companies are ready to generate similar profits once again. More importantly, what would that mean for the stocks of these companies? The Energy Select Sector SPDR ETF (XLE -0.74%), an ETF of top oil and gas stocks, has already risen roughly 40% in a year.
Two Foolish contributors share their thoughts about the future of oil and gas stocks.
Higher prices seem to be here to stay for a while
Matt DiLallo (Bull case): The past several years have been tough for the oil and gas market. Crude oil prices crashed twice (in 2014 and 2020), unleashing a devastating wave of bankruptcies across the oil patch. With that pain still fresh in the minds of the industry, it's taking a more cautious approach now that oil prices are higher.
Instead of reinvesting the cash flows they produce at higher oil prices on drilling more wells, oil and gas companies are returning the bulk of that windfall to investors via share repurchases and dividends. This trend has a dual benefit for oil and gas stocks. First, it's giving investors a tangible return. Meanwhile, it will likely keep a lid on supplies, which should support higher oil prices.
In the midst of all this, the oil market faces high geopolitical risk, given Russia's recent moves against Ukraine. Because Russia is a major oil and gas producer, this could have big implications for the energy markets. For example, Germany has already halted approval of the Nord Stream 2 pipeline, which would move natural gas from Russia to Germany, following Russia's movements in Ukraine. If more countries take political actions against Russia's energy industry, it could put further pressure on global oil and gas supplies and push prices even higher.
Given these dynamics, it seems likely that oil and gas prices will remain elevated for quite some time. Even if U.S. producers accelerate their drilling programs (something their investors don't want to see), it will take months for that new production to come online. Meanwhile, the country lacks the pipeline and export infrastructure to move additional supplies to global markets. Because of that, oil and gas companies appear poised to generate a gusher of cash in the coming months, which should give their stocks the fuel to keep heading higher.
The longer-term outlook for oil isn't exactly enticing
Rekha Khandelwal (Bear case): Oil and gas stock prices get impacted by numerous factors, the top one being oil prices. Oil prices, in turn, tend to be volatile and unpredictable. Certain factors make oil and gas stocks unattractive right now.
To be clear, the demand for oil and gas isn't going away overnight, as some renewable energy enthusiasts argue. The U.S. Energy Information Administration projects that even though the percentage share of oil and gas in the global energy mix is expected to fall by 2050, their absolute consumption will continue to rise. Despite this positive outlook, oil and gas companies may not see the kind of strong growth that they witnessed in the past. Increasing the use of renewable energy sources will restrict oil's growth. That is likely the reason behind the lukewarm attitude of investors toward oil and gas stocks, despite strong oil prices.
With the West Texas Intermediate (WTI) crude oil price close to around $95 per barrel, there is only one direction it can go from here: down. Even if prices stay at current levels for a while (or rise temporarily) due to geopolitical uncertainties, they will most likely normalize either when the issues resolve or as other oil-producing nations ramp up production. In short, the rally in oil prices could be short-lived.
Should you buy oil and gas stocks now?
Years of underinvestment in exploration and production projects mean that oil production may not be quickly restored to meet rising demand. That may help sustain oil prices for a while. However, prices are eventually bound to fall from their current high levels. Nobody can say for sure when that will happen -- it could be anywhere between a few days to a couple of years. Oil and gas stocks, which follow oil prices at large, may tumble once oil prices correct.
If you are looking to invest in oil stocks that generate relatively stable cash flows, regardless of oil prices, such as Enbridge or Enterprise Products Partners, now could be as good a time as any. However, if you're looking to benefit from the short-term volatility in oil prices, you could be disappointed if prices don't move as you're hoping.