Crude oil prices have risen roughly 50% since November, significantly lifting the prices of energy stocks. Surely, higher oil and products prices benefit energy companies, from upstream producers to downstream refiners. However, before buying energy stocks, you should consider how badly a company's performance will be affected if oil prices fall again -- a very plausible scenario given oil's historical volatility. Here are three energy stocks to avoid unless you are super confident in steady oil prices from here on.
Integrated oil and gas giant BP
Oil and gas major BP (BP 0.55%) faces two key challenges that make me wary of buying it right now. The first one is the company's debt load. BP is the most leveraged among top integrated oil companies. It's debt-to-equity and debt-to-capital ratios are highest among its top peers by a considerable margin.
BP Debt to Equity Ratio data by YCharts
The high debt load forced the company to slash its dividend in half last year. Though that helped it save roughly $1 billion, its net debt is still much higher than its targeted level of $35 billion.
The second concern stems from BP's strategy of diversifying away from oil and gas and toward renewables. Considering the expected growth in the demand for renewable energy, this looks like a sound strategy. However, profits of renewable companies have largely been erratic so far. It'll be a challenge for BP to generate steady profits from a business that's new for it. Of course, the company can backtrack from renewables, the way it did in 2000s with its "beyond petroleum" positioning, but that doesn't exactly sound enticing to me. Investors looking to invest in integrated oil companies will surely find better options elsewhere.
Image source: Getty Images.
Downstream refiner PBF Energy
Squeezed refining margins and lower refined products demand have significantly impacted the performance of all refiners. That should improve as the demand for refined products returns. However, PBF Energy (PBF 3.44%) doesn't look like one of the better-placed refiners to weather challenging patches like the current one. PBF Energy has one of the most bloated balance sheets among independent refiners.
PBF Debt to Equity Ratio data by YCharts
Unlike most of its peers, PBF Energy has been burning cash for the last three quarters.
PBF Cash from Operations (Quarterly) data by YCharts
In response to lower demand, PBF Energy idled some units of its Delaware City and Paulsboro, New Jersey, refineries in October, reducing capacity by 85,000 barrels per day. The refiner's weak performance resulted in a steep fall in its stock price and a surge in its dividend yield.
PBF Dividend Yield data by YCharts
With a 45% rise in its stock price so far in 2021, PBF Energy stock has recovered some of its losses. But it makes sense to stick with stronger companies should demand recover slower than expected or oil prices turn volatile once again.
Offshore driller Transocean
Transocean (RIG 1.00%) stock has more than quadrupled from its levels in November. Stronger oil prices have made investors hopeful of increased offshore drilling activity in future. While that could well be the case, the company faces big risks if oil prices fall again. Lower oil prices, higher production costs, and risks associated with offshore drilling have been impacting the offshore drilling industry since 2014. Demand destruction resulting from COVID-19 added to the woes, causing prominent offshore drillers to go bankrupt.
Transocean, too, has been reporting losses for the last several quarters. Low oil price environment reduced oil producers' appetite to explore and develop new offshore resources. More rigs than needed forced drillers to idle some rigs. Like its peers, Transocean too has been finding it difficult to contract rigs at profitable rates. That could continue to be the case, unless oil price sustain at levels high enough to incentivize producers to sanction new offshore projects.
RIG Net Income (Quarterly) data by YCharts
In the third quarter, Transocean posted a net profit of $359 million. However, on an adjusted basis, it reported a loss of $69 million for the quarter. That's higher than an adjusted loss of $1 million in the second quarter of 2020.
Stable or rising oil prices can continue supporting Transocean's stock price. However, oil producers' investments in offshore projects could fall if oil prices remain low. So, Transocean stock price could continue to be volatile. Investors looking to invest in the energy sector can find smarter alternatives elsewhere.
This article represents the opinion of the writer(s), who may disagree with the "official" recommendation position of a Motley Fool premium advisory service. We're motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
