Oil prices have risen sharply amid escalating geopolitical tensions in the Middle East. There are very real reasons for the price spike, given that the energy markets have been materially disrupted by recent events. However, make sure you consider these three facts before buying oil stocks simply because oil prices are on the rise.
1. Oil is an inherently volatile commodity
Wall Street has a very short memory, with investors often swept up by short-term events that history shows are unlikely to last. Today's rising oil and natural gas prices are one very poignant example. While it is true that higher oil prices will likely result in strong earnings for energy companies, the industry's history is filled with periods where dramatic commodity declines have led to exactly the opposite outcome.
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Buying just because oil prices are high is not a great plan for a long-term investor. You will most likely end up buying at elevated valuations.
2. Diversification has its benefits
If you are still intent on buying an energy stock today, you have to understand that there are different ways to get that exposure. For example, Devon Energy (DVN +0.62%) is a pure play North American energy producer. It is insulated from the direct physical impact of the geopolitical conflict and will benefit directly from rising oil prices. However, it will also be hit hard if, more likely when, oil and gas prices decline. A better choice would be a diversified business like Chevron (CVX -0.22%).
Chevron is an integrated energy company. It produces oil and natural gas, it transports these commodities, and it processes them. The company also has geographic diversity, with assets spread around the world. And it has one of the strongest balance sheets in its peer group. Notably, the stock's dividend has been increased annually for decades. If you are inclined to buy an energy stock today, Chevron has proven it can survive through the full energy cycle while still paying investors well along the way.
NYSE: CVX
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3. You can play a different game
That said, you can sidestep energy prices and still invest in the energy sector by buying a midstream business like Enterprise Products Partners (EPD -0.23%). This pipeline operator collects fees for moving oil and gas around the world, with demand for energy being a more important driver of its results than commodity prices. The lofty 5.8% yield will account for most of your return over time, but a boring income investment will likely be a better fit for many investors when it comes to energy stocks.
In the end, history suggests that buying an energy stock just because of high oil prices is a risky move. It is much better to take a full-cycle view of the sector and invest accordingly in diversified companies, like Chevron, and businesses that don't depend as heavily on commodity prices, like Enterprise.
