Oil stocks are getting hammered as plunging crude oil prices take a bite out of stock prices. Just look at the one-week chart of independent oil and gas producers Cimarex Energy (NYSE:XEC), EOG Resources (NYSE:EOG), Anadarko Petroleum (NYSE:APC), Newfield Exploration (NYSE:NFX), and Pioneer Natural Resources (NYSE:PXD).
These five oil stocks were among the worst-performing stocks on the S&P 500 on Monday. The shellacking came after the price of global crude oil benchmark Brent slipped below $100 per barrel for the first time in over a year amid worries that Chinese demand is growing slower than expected.
With these oil stocks now seemingly on sale, is now the time to buy?
Don't act surprised
First of all, we shouldn't be surprised to see oil stocks fall alongside oil prices. There's almost a direct correlation between the two, as this next chart shows.
I recently pointed out this correlation in a series of articles covering some of America's top independent oil and gas companies, including EOG Resources and Pioneer Natural Resources. I specifically pointed out that leverage to oil could cause EOG Resources' stock price to fall if oil prices plunged, while also noting that falling oil prices were one of three reasons why Pioneer Natural Resources' stock could lose value. However, I concluded in both articles that lower petroleum prices could offer a buying opportunity for these stocks.
There are three reasons that reduced oil prices could be a buying opportunity for oil stocks. First, these companies are sitting on an enormous amount of oil and gas that can be extracted profitably even if oil prices fall further. For example, Pioneer Natural Resources believes it is sitting on one of the biggest oil fields ever discovered in the U.S., and that its position holds upward of 10 billion barrels of oil and gas. EOG Resources, Anadarko Petroleum, Cimerex Energy, and Newfield Exploration are similarly optimistic about their opportunities. These enormous resources, along with the high margins from shale drilling, mean oil companies should profit even if oil prices move lower.
That being said, oil prices might not have much farther to fall. Companies are already beginning to cut back investment in new oil growth projects around the world. This comes after the industry found itself drowning in high-cost projects. That's a problem because the cheap oil is gone, so oil companies need higher oil prices in order to earn sufficient returns on new projects. Deepwater driller Seadrill (NYSE:SDRL) recently noted that this scenario is similar to that experienced in 2002 and 2003, when oil companies had limited free cash flow to develop new reserves. Companies at that time underinvested in oil growth projects and supplies fell, which caused oil prices to rise again. Assuming Seadrill's correlation is valid, this would appear to foreshadow a future spike in oil prices.
The last reason falling oil prices could be a buying opportunity for oil stocks is that there is very compelling data that suggest petroleum consumption should rise in the future. ExxonMobil's (NYSE:XOM) 2014 outlook for energy projected global energy demand rising 35% by 2040. While the company said it sees much future growth for renewable energy and natural gas, it anticipates oil will provide the largest share of global energy in 2040. Emerging economies in Asia-Pacific are expected to account for 65% of the global demand increase. A big driver of this increase will be transportation fuels, which are expected to see demand surge 40%, largely driven by diesel due to increased commercial activity. Needless to say, this fuels a bullish thesis for future oil prices.
While oil prices could certainly have farther to fall in the shorter term, the long-term outlook suggests they could easily head higher at some point. This indicates the sell-off in oil stocks could be a buying opportunity, especially if their prices continue to drop in lockstep with lower oil prices. That's why investors should begin to at least make a watchlist of oil stocks they'd like to buy, as these companies are sitting on enormous oil reserves that have the potential to deliver a lot of value over the long term.