Investors in the energy sector have been on quite the roller coaster ride this past year. Oil stocks saw some pretty precipitous declines in early 2020 amid the onset of the coronavirus pandemic. While the recovery appears to be in full swing in the energy sector, it’s important to reflect on the pain inflicted on energy investors just a year ago.
Supply and demand fundamentals in the oil sector were already under siege prior to the pandemic. Accordingly, the rather bearish estimates of demand over the medium-term due to the pandemic sent oil futures prices negative for the first time ever.
Fast forward a year later, and it’s as if nothing happened. Oil prices, both Brent and WTI Crude, now trade at roughly the same levels immediately before the onset of the pandemic. It appears investors are bullish on medium-term demand coming out of this pandemic. Additionally, some high-cost supply has been taken off the market, and OPEC+ has remained relatively accommodative in terms of supply cuts (though these supply cuts are expected to be gradually removed over time as demand improves).
Massive amounts of stimulus have also weakened the U.S. dollar of late. This is broadly bullish for commodities, and is viewed as a key catalyst for the energy sector right now. As long as the U.S. dollar remains low, and demand materializes at a pace investors expect, many expect oil to trade in and around its current band for some time.
In such a bullish scenario, these seven stocks could likely continue to see some near-term stock price appreciation. However, these seven picks are also companies I’d recommend investors consider in any environment. For those looking to diversify into energy, but are wary of the effect oil prices can have on producers, these seven are among the most defensive long-term picks today:
- Royal Dutch Shell (NYSE:RDS.A, NYSE:RDS.B)
- Exxon Mobil (NYSE:XOM)
- Chevron (NYSE:CVX)
- Phillips 66 (NYSE:PSX)
- Total (NYSE:TOT)
- Valero (NYSE:VLO)
- Suncor (NYSE:SU)
Oil Stocks: Royal Dutch Shell (RDS.A)
The fourth-largest oil producer in the world seems like a good place to start.
Royal Dutch Shell is massive in more ways than one. The company’s core oil production business is complemented by midstream and downstream operations resulting in a global juggernaut of a vertically integrated energy producer.
Those who have visited one of Shell’s 25,000 gas stations in the U.S. know the downstream reach of Shell. Indeed, it’s one of the most recognizable names in the energy space for a reason. The company’s global brand is one of the best, and continues to provide this oil producer with a larger moat than many of its smaller cap peers today.
Recently, the company reported it expects to earn its first profit since the beginning of the pandemic. Accordingly, it may be surprising to some investors that Shell’s stock price has been on a steady decline this past month. Investors can now buy shares of Shell at roughly the same level as the beginning of the year. Furthermore, RDS stock trades at a discount of roughly 25% to pre-pandemic levels.
Well, it appears the energy sector is one that still has a long way to go in terms of recovery. The effects of the pandemic have hit the company’s operations hard. Accordingly, RBC analyst Biraj Borkhataria commented in a recent note, “Operationally, the business appears to be performing below expectations.”
However, Mr. Borkhataria also commented “we do not think it materially alters the investment case into 2021.”
Right now, Shell’s size makes the company representative of the entire energy sector. Accordingly, investors buying into Shell are buying into the broader recovery thesis with this stock. Yes, there’s more that needs to be done for this sector to fully recover. However, those confident in such a rebound will note there’s likely at least 25% upside with a stock like Shell in such a scenario.
Exxon Mobile (XOM)
Moving down the list to the world’s sixth-largest oil producer, we have Exxon Mobil.
Exxon is one of those oil stocks that has been a multi-generational gem for investors. With a history that dates back to 1870, Exxon’s historical returns have been the focus of investors for decades. The company’s reliable streak of raising its dividend each and every year came to an end in 2020. This broke a streak of nearly four decades of dividend hikes, and was cause for concern among many investors buying XOM for its income growth potential.
Indeed, Exxon was among the hardest hit companies in the pandemic. Its operations, like those of Shell, are extremely vertically integrated, and one would have hoped the company would be spared from the turmoil that occurred. However, given the shift toward value we’ve seen take place in recent months, investors have simply rotated into higher-growth options away from the slow-and-steady gems like Exxon.
Investors may also be dissuaded by the fact that Exxon was recently removed from the Dow Jones after a run of nearly one century. That said, there’s room for optimism among investors who note that delisted companies often perform better in the years after delisting.
Indeed, Exxon remains a dividend gem, despite its willingness to preserve cash to bolster its balance sheet last year. Its dividend yield remains a healthy 6.2.%. For those bullish on a continued recovery in oil prices, Exxon is one of the key oil stocks with a ton of room to run from here.
Similar to its peer Exxon, Chevron’s days on the Dow may be numbered. It’s a company with a slightly smaller market cap than Exxon, but remains listed on the Dow, and is seen as one of the best oil players out there today. (There were actually indications Exxon and Chevron could have merged last year.)
But that’s neither here nor there.
Chevron’s stock price has recovered to trade right around January 2020 levels. This appears to be an indication investors have not lost faith in this particular oil player. Indeed, I think the market is spot on in this case.
The fact that Warren Buffett has stepped into Chevron is a good sign. The long-term, conservative investor is betting big on the oil producer.
Well, it was disclosed that Buffett invested approximately $4.5 billion in Chevron. That’s no small bet, and amounted to roughly 2.5% of the oil producer at the time of his investment. This is also one of his investments he’s kept closest to his chest, disclosing only at the last possible moment.
It appears the Oracle of Omaha is bullish on Chevron’s high-quality assets and long-term growth potential. I also think it’s key to consider his choice of Chevron over Exxon or other large-cap peers. Chevron indeed appears to have a better-looking balance sheet right now, and the ability to provide better returns long-term.
It’s also about total return, and Chevron’s 5% dividend yield helps in that regard. For investors seeking growth, yield and defensiveness — this is a great pick.
Phillips 66 (PSX)
As a midstream/refining play, Phillips 66 has been on my watch list for some time. Given the fact that this company is a midstream player is important. It’s not a pure-play oil producer, so the rise or decline of commodity prices don’t have as large an effect on its balance sheet as it does on some other oil stocks.
But they do have an effect.
One of the drivers of lower commodity prices of late has been deteriorating demand through the pandemic. Refining utilization rates plummeted as we all kept our cars in the garage. Jet fuel refining business plummeted to a degree we haven’t seen since 9/11 and the previous financial crisis.
That said, there’s reason to be optimistic here.
Phillips 66 is a unique oil player in the sense that this company is making big-time pivots in real time toward renewable energy. The company announced plans to transform a San Francisco refinery into the world’s largest renewable fuels plant. Accordingly, Phillips 66 is trying to get ahead of the curve with respect to the adoption of renewable fuels. There’s a long-term growth thesis with this stock as it transforms its business model. Indeed, if this experiment proves fruitful, I expect to see more of a corporate shift on the horizon.
Absent this extremely positive catalyst, Phillips 66’s cash flow situation looks much better than its peers right now. Accordingly, this is a stock I’m keeping on my radar right now.
Like many of its carbon-producing peers, Total is making some pretty drastic, transformative moves. In January, the company announced a $2.5 billion investment in Indian company Adani Green Energy. The deal represents a 20% minority stake in the company. Additionally, this is but one of a flurry of deals Total has reported to get toward its internal net-zero carbon goal.
As a result of the deal, France-based Total has amassed the largest renewable energy portfolio of its European peers.
For those concerned about big oil being regulated out of the picture long-term, that’s a great thing. Total is taking an aggressive, pro-active approach to the progressive decline in carbon production it sees as inevitable.
Well, CEO Patrick Pouyanné was recently quoted as saying the company looks to transition toward a business model in which 40% of its energy is produced by renewable sources. The remaining business will be split between natural gas (40%) and oil (20%) production.
This is a big shift from the company’s existing business model. Currently, roughly 55% of Total’s operations are tied to oil, with 40% coming from gas and 5% from renewables.
Those looking for the oil producer of the future have found it. Total is putting its money where its mouth is to make it so, and that makes it one of the few oil stocks worth buying now.
Like most of its fellow oil stock peers, Valero’s stock price has rallied, but not yet back to pre-pandemic levels. The refiner was hit with an incredible collapse in demand for refined fuels. According to some estimates, this demand drop amounted to a 9% decline from 2019 to 2020.
While oil prices had a rough decade post-2008, refiners like Valero actually benefited somewhat in this environment. That’s because oil is an input in the refining process. Lower input costs translate into higher margins. All good for Valero.
However, the pandemic-driven plunge in oil prices wasn’t the major cause for concern for Valero shareholders. Rather, it was the aforementioned collapse in demand which caused so much pain. We’re all driving less than before, and flying a heck of a lot less than before. This is generally extremely bearish for investors in companies providing the fuels we need to get from A to B.
Fast forward a year later, and demand expectations have picked up drastically. There’s now hope that the massive vaccination program underway globally could result in pre-pandemic demand levels sooner than later. Accordingly, VLO stock has been on a nice tear since the beginning of the year, up more than 27% at the time of writing.
As far as oil stocks go, refiners like VLO and PSX have been on my list for some time. I’d highly recommend investors considering oil stocks look at midstream and downstream players, if looking to play the rebound in demand. That’s where the value will be.
Suncor is one of the more intriguing oil stocks on the list. That’s because this oil producer is focused on neither Brent nor WTI oil production.
Rather, Suncor’s core business is in the Canadian oil sands sector. The Alberta-based oil producer primarily focuses on heavy oil production priced under Western Canadian Select (WCS) prices.
Unfortunately for many investors, WCS prices trade at a discount to WTI and Brent, and always have. Given pipeline issues in Canada, getting oil to key U.S. refiners has become more difficult. A backlog of supply has ensued, with WCS discounts expanding drastically in recent years.
The Alberta government imposed supply restrictions to try to narrow the discount to more reasonable levels. This move, combined with rising WTI prices, has led producers like Suncor to record massive cash flow growth in recent quarters.
Suncor’s current breakeven price per barrel sits at around $40 WTI. Given where oil prices are today, that makes Suncor an intriguing play. Additionally, Suncor’s business model is considered to be more highly leveraged to the price of oil than light or “sweet” oil producers. Accordingly, for those bullish on a rebound in oil prices, this is a great way to play this trade.
Warren Buffett has been a recent bull on Suncor, adding an initial position in 2019, adding to and then trimming this position in 2020. Any time the Oracle of Omaha gives any stock a thumbs up, it’s worth a look.
On the date of publication, Chris MacDonald did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Chris MacDonald’s love for investing led him to pursue an MBA in Finance and take on a number of management roles in corporate finance and venture capital over the past 15 years. His experience as a financial analyst in the past, coupled with his fervor for finding undervalued growth opportunities, contribute to his conservative, long-term investing perspective.