Better Buy: Kinder Morgan vs. ONEOK
These pipeline giants offer investors big-time yields.
An oil company is an entity engaged in at least one of the following three activities:
The oil industry is rapidly changing in the current economic climate. Find the latest information in the newsfeed at the end of this article.
Oil companies are crucial to the global economy because they provide the fuel needed for transportation and power, as well as the building blocks of petrochemicals.
However, the oil industry is highly competitive and volatile. Because of these and other factors, investors need to tread carefully around the oil patch, especially when it comes to the companies that explore for and produce oil and gas. Here's a closer look at the factors to consider before buying oil stocks, as well as the top companies in the sector.
The oil industry is inherently risky for investors. While each segment has a specific set of risk factors, the overall business is both cyclical and volatile.
Oil demand grows along with the economy, which when robust can support higher oil prices and producer profitability. However, geopolitics and capital allocation also play crucial roles in the industry. Several large oil-producing nations are part of OPEC, an organization that works to coordinate national oil policies. OPEC's actions can significantly affect the price of oil. Meanwhile, oil companies that operate independently of OPEC can also have an impact on the oil market if they allocate too much or not enough capital to new oil projects.
Given the volatility in oil prices, an oil company must have three crucial characteristics to survive the industry's inevitable downturns.
With those factors in mind, here are three top oil stocks worthy of investors' consideration:
ConocoPhillips (NYSE:COP) is one of the largest E&P-focused companies in the world, with operations in more than a dozen countries. It also produces oil using a variety of sources and methods, including horizontal drilling and hydraulic fracturing of shale in the U.S., oil sands mining in Canada, and deepwater drilling, as well as other conventional production techniques elsewhere around the world.
ConocoPhillips' diversified portfolio has low supply costs, with a significant portion of its oil reserves economical below $40 a barrel. Because of that, the company can produce a substantial amount of cash flow at lower oil prices. Its 10-year plan, which covers 2020-2029, forecasts that it can generate $120 billion in cumulative cash flow if oil averages $50 a barrel. It intends to invest $70 billion of that money to sustain and grow its production while returning the other $50 billion to investors via dividends and share repurchases.
Finally, the company complements its diversified, low-cost portfolio with a top-tier balance sheet. ConocoPhillips routinely boasts one of the highest credit ratings among E&P companies, backed with a low leverage ratio for the sector and lots of cash. Because of this, it's highly resilient to lower oil prices, making it one of the best-positioned oil companies to handle the sector's volatility.
Kinder Morgan (NYSE:KMI) is one of the largest energy infrastructure companies in North America. It operates the continent's biggest natural gas pipeline network, and it’s a leader in transporting refined petroleum products and storing oil and refined products. Finally, it's a major carbon dioxide transportation company, using CO2 to produce oil in Texas by injecting it into aging oil fields to coax more crude oil out of the ground.
Kinder Morgan has minimal direct exposure to oil prices because it generates most of its income from fee-based contracts. Overall, those agreements typically support more than 90% of the company's annual earnings, with about two-thirds having no volume risk (meaning customers pay the company even if they don't use their contracted capacity). While about 10% of the company's cash flow usually has some direct exposure to commodity prices, Kinder Morgan typically secures hedging contracts to lock in pricing on about half of those earnings. Because of that, the company generates stable cash flow each year.
Finally, Kinder Morgan has a strong investment-grade balance sheet. That provides it with the financial flexibility to continue making growth-related investments as well as return cash to shareholders via its buyback and dividend, even during rough patches.
Phillips 66 (NYSE:PSX) is one of the leading refining companies, with operations in the U.S. and Europe. It also has investments in midstream -- including control of two master limited partnerships, Phillips 66 Partners (NYSE:PSXP) and DCP Midstream (NYSE:DCP) -- and in chemicals via its CPChem joint venture with Chevron (NYSE:CVX). Finally, its marketing and specialties business distributes refined products and manufacturer specialty products like lubricants.
Thanks to its large-scale operations, Phillips 66 is among the lowest-cost producers in its industry. The company, for example, leverages its midstream network to provide its refineries and petrochemical facilities with low-cost oil and NGLs. It also focuses on producing higher-value products like low-sulfur diesel, which boosts its profitability. Finally, it invests in projects that improve its margins, especially on the refining side.
Phillips 66 also boasts a strong financial profile, which includes an investment-grade balance sheet, well-laddered debt maturities, and lots of liquidity. Those factors provide it with the financial flexibility to invest in expansion projects, pay an attractive dividend, and repurchase shares.
The oil market can be quite fragile, with a slight imbalance between supply and demand often causing it to go haywire. Because of that, investors need to be careful when choosing oil stocks. Focus on oil companies that can survive rough patches; they’ll be better positioned to thrive when markets turn healthy again.
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