Top oil and gas stocks are trading near multi-year lows. Investors' interest in the sector is at its lowest point in decades. Some believe that the era of oil and gas, just like coal, has gone. Does it mean that you should get rid of your oil stocks?
Rock-bottom stock prices
No matter what timeframe you look at, oil and gas stocks are invariably in the red. From upstream heavyweight ConocoPhillips (COP 0.29%) to top downstream player Phillips 66 (PSX -2.00%), the gloom in the sector hasn't left any segment untouched. This is also true for integrated giants ExxonMobil (XOM -0.36%) and Chevron (CVX 1.89%).
The graph below captures performance over five years.
Weary investors just want some relief. And some investors feel the best way to get it is to sell all their oil stocks. If you feel the same, hold on.
First and foremost, such a step is squarely against the fundamental investing principle of 'buy low, sell high.' If anything, the current low prices provide an entry opportunity, surely not an exit point. But what if the stocks continue to fall, and oil and gas never achieves back the status it once enjoyed in meeting global energy demands? There is ample evidence that suggests the contrary.
Oil prices
WTI crude oil prices averaged $40.93 in Q3, a significant rise from an average of $27.96 in the second quarter. Sure, the prices are not at a level which will allow oil companies to churn huge profits. However, they have improved from the lows in Q2, reflecting demand recovery post shelter-at-place orders. That's a good sign for oil companies.
Image source: Getty Images.
ConocoPhillips' third quarter preliminary results reflect the positive developments in the oil markets. Based on the preliminary estimates, the company's oil-equivalent production in Q3 rose 8% over Q2. Though it's still down 20% compared to the year-ago quarter, the company fully restored production in the U.S. and Canada by the end of the third quarter. That gives ConocoPhillips the confidence to be in a position to resume its share repurchase program in Q4.
It is difficult to predict where oil prices are headed. It is widely believed that oil may not enjoy the high price levels it saw prior to 2014. If prices indeed remain low around the 'new normal' levels, several smaller, high-cost producers may go out of business. However, companies that have the lowest production costs and least leverage should survive, and thrive, in the long run. ExxonMobil and Chevron fall in this category.
XOM Financial Debt to Equity (Quarterly) data by YCharts
As the above graph shows, both ExxonMobil and Chevron are less leveraged compared to BP or Royal Dutch Shell.
The future of oil and gas
The biggest concern of oil investors today is the possibility that renewable fuels will eventually replace oil and gas as energy sources. Surely, this fear is not baseless. However, such a transition is not going to happen overnight. The International Energy Agency projects global oil demand to keep rising beyond 2040 under policies in effect currently. However, if the countries globally transform energy systems with an eye on environment and climate change, the oil demand will peak quickly. This doesn't seem to be happening at the moment. Even if it happens, oil and gas will continue to contribute a major chunk of global energy needs for decades to come.
With rising population and living standards, the global energy demand, especially from developing economies, will keep rising. It will be met by a combination of different sources including fossil fuels and renewables. In short, top oil and gas companies will likely continue to generate steady cash flows for years to come.
Dividend income
Finally, oil stocks offer attractive yields. With improving oil markets, dividends of Chevron, ConocoPhillips, and Phillips 66 look safe at the moment. ExxonMobil is committed to maintaining its dividends, though that may not necessarily be the best use of its capital. Moreover, maintaining dividend looks more difficult as lower gas prices and squeezed refining margins are expected to hit ExxonMobil's Q3 results.
XOM Dividend Yield data by YCharts
Oil and gas stocks may not see the phenomenal growth in earnings that they enjoyed during the shale boom. However, positive long-term demand position for oil makes the outlook for top oil companies upbeat. Companies are adapting to lower oil prices by focusing on reducing production costs. At the same time, the impacts of COVID-19 should continue to lessen over time. Top oil companies have a fair chance of coming out of the current mess. In short, selling your oil stocks may not be the best idea today.
