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Investing in Top Oil Stocks

Updated: Nov. 22, 2021, 11:25 a.m.

An oil company is an entity engaged in at least one of the following three activities:

  • Upstream exploration and production (E&P) of oil and natural gas, as well as oilfield services.
  • Midstream transportation, processing, and storage of oil and related liquids, including refined petroleum products and natural gas liquids (NGLs) such as ethane and propane.
  • Downstream refining and distribution of petroleum products.
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The oil industry is rapidly changing in the current economic climate. Find the latest information in the newsfeed at the end of this article.

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Oil companies are crucial to the global economy, providing fuels for transportation and power, as well as the core ingredients of petrochemicals used to make products, including plastics, rubber, and fertilizers, that we rely on every day.

However, the oil industry is highly competitive and volatile, and profits and losses can swing wildly based on small shifts in demand or moves by petrostates such as Saudi Arabia and Russia whose interests can run counter to the public companies in the industry.

Additionally, investors must consider the implications of climate change for the long-term prospects of oil and gas. The energy sector is changing a lot, and renewable energy companies are taking more market share. Even so, that doesn't mean there are few opportunities in the oil patch. Here's a closer look at some of the top oil stocks and factors to consider before buying oil stocks.

Oil rig silhouette against a reddish golden sunset.

Image Source: Getty Images

What are the top oil stocks to invest in?

With the oil industry’s headwinds in mind, three top oil companies worthy of investors' consideration include ConocoPhillips (NYSE:COP), a global exploration and production company; Exxon Mobil (NYSE:XOM), a large-scale, integrated supermajor; and Phillips 66 (NYSE:PSX), a leading refining company with midstream, chemical, and distribution operations.

Read on to learn more about each of these.

ConocoPhillips

For investors looking to capitalize on rising oil prices and steady demand, ConocoPhillips is worth considering. One of the largest E&P-focused companies in the world, it specializes in finding and producing oil and natural gas and has operations in more than a dozen countries.

ConocoPhillips benefits from scale and access to some of the lowest-cost oil on earth, which includes significant exposure to the Permian Basin via its 2020 acquisition of Concho Resources (NYSE:CXO). With average costs of about $40 per barrel and many of its resources even cheaper, it can make money in almost any oil market environment. The company plans to return its entire market cap in dividends and share repurchases over the next decade as long as Brent Crude prices average only $50 per barrel.

Finally, the company complements its low-cost portfolio with a top-tier balance sheet. ConocoPhillips routinely boasts one of the highest credit ratings among E&P companies, backed by a low leverage ratio for the sector and lots of cash.

Add it all up, and ConocoPhillips has consistently been able to generate positive cash flows while paying out a dividend it's raised six times since 2015.

ExxonMobil Corp.

One of the largest oil companies on the planet, ExxonMobil is a fully-integrated supermajor. It operates in every segment of the oil and gas industry, including E&P, midstream, petrochemical manufacturing, refining, and, even farther downstream, marketing refined and petroleum products to customers.

The past decade hasn't been great for the company. Profits have steadily declined during that time, it was removed from the Dow Jones Industrial Average after more than a century in the index, and the climate-focused hedge fund Engine No. 1 successfully captured three seats on its board in May 2021.

But more recent efforts to reduce its business costs and boost efficiency are beginning to pay off. It has lowered its oil production costs significantly over the past couple of years by focusing on its highest-return assets while also taking steps to better leverage its massive scale.

As a result of those improvements and a recovery in oil prices and global demand, its cash flows are surging. That should continue to protect ExxonMobil's dividend and its status as a Dividend Aristocrat. With the concerns about the growth of renewables, and many investors choosing to avoid oil stocks entirely, ExxonMobil's stock price could remain undervalued for an extended period of time, offering one of the better dividend yield opportunities on the market.

Phillips 66

Phillips 66 is one of the leading oil refining companies, with operations in the U.S. and Europe. It also has investments in midstream operations -- including sizable stakes in two master limited partnerships, Phillips 66 Partners (NYSE:PSXP) and DCP Midstream (NYSE:DCP) -- and in petrochemicals via its CPChem joint venture with Chevron (NYSE:CVX). Finally, its marketing and specialties business distributes refined products and manufactures specialty products such as lubricants.

Thanks to its large-scale, vertically integrated operations, Phillips 66 is among the lowest-cost refiners in its industry. This is the result of both leveraging its integrated midstream network to source lowest-cost crude for refining and petrochemical feedstocks and investing in projects that give it higher margins on the products it makes.

Phillips 66 also boasts a strong financial profile, which includes an investment-grade balance sheet with very manageable debt, plus it has lots of cash on hand. These factors mean it has ample capital to invest in expansion projects -- including a surprising focus on renewable fuels.

It's also been a dividend growth superstar and a share buyback dynamo over the past decade.

Investors looking to profit from oil stocks and gain exposure to renewables should give Phillips 66 a close look.

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How to analyze oil stocks

The oil industry is inherently risky for investors. While each segment of the industry has a specific set of risk factors, the overall oil business is both cyclical and volatile.

Oil demand generally tracks economic growth. A robust economy can support rising oil prices and oil producer profitability. However, geopolitics and capital allocation also play crucial roles in the industry.

The world’s largest oil-exporting nations include members of OPEC (Organization of the Petroleum Exporting Countries), a cartel that works to coordinate members’ oil policies. OPEC's actions can significantly affect the price of oil; in 2020, its members slashed prices to persuade Russia to curb production. Within a month, oil futures prices had gone negative, and producers were paying people to take their oil.

Meanwhile, oil companies that operate independently of OPEC can also have an impact on oil prices if they allocate too much or not enough capital to new projects. Since oil and gas assets are developed over a long time, companies cannot quickly increase their supplies in response to favorable market conditions.

Given the volatility of oil prices, an oil company must have three crucial characteristics to survive the industry's inevitable downturns:

  • A strong financial profile with an investment-grade bond rating, significant amounts of cash on hand or ample access to affordable credit, and manageable, well-structured debt maturities.
  • Low costs of operations or relatively stable cash flow streams. E&P companies need to be able to profitably sustain operations at oil prices below $40 a barrel, while midstream companies should get more than 85% of their cash flow from steady sources such as fee-based contracts. Downstream companies should have operating costs below the industry average.
  • Diversification. Oil companies should operate in more than one geographical region or be at least partially vertically integrated by engaging in several different activities.

Risk management is the key to investing in the oil patch

The oil market can be quite fragile, with a slight imbalance between supply and demand often causing it to go haywire. That was abundantly evident in early 2020 as the COVID-19 pandemic sent the sector into a tailspin. As a result, investors need to be careful when choosing oil stocks. Focus on oil companies that can survive rough patches since they’ll be better-positioned to thrive when markets turn healthy again.

FAQs

How do I invest in oil stocks?

It's important for investors to be aware of the oil sector's volatility. Because of that, it's best to focus on companies built to weather the sector's inevitable downturns. That means focusing on those with relative immunity to price fluctuations, such as E&Ps with ultra-low production costs and integrated oil giants. Another way to invest in the oil patch is to focus on using it to generate dividend income.

Are oil and gas companies a good investment?

While oil and gas is a comparatively risky sector, some companies are safer than others. Petroleum-based fuels and natural gas usually have a cost advantage over other heating and transportation fuels, and they have a massive infrastructure advantage over emerging clean energy fuels. That said, the industry also has some negative features that increase risk for investors.

Should I invest in oil and gas companies now?

The coronavirus pandemic caused global oil demand to crash while oil producers slashed their output to ride out the downturn. But, as travel and commerce recovered, it led to the demand for oil products recovering faster than production could respond. As a result, oil prices have returned to recent pre-COVID levels.

The tightening of supply and the recovery in global demand certainly bodes well for many oil and gas companies, and some could be huge winners in the near term. However, if energy investors should have learned anything over the past decade, it's that market conditions can change quickly. For this reason, most investors considering oil stocks would do well to focus on high-quality, larger integrated oil companies such as the ones described in this article.

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