A slump in the price of oil has seen oil stocks diverge from the pack in recent weeks. While the Nasdaq and S&P 500 have been enjoying a healthy upswing, energy stocks - even those with good dividend yields are out of favour. Could that be about to change?
The healthy 9%+ return for the S&P 500 since January seems to be primarily 'tails-driven' with big gainers like Nvidia Corp (up 158%), Meta Platforms (+119%), and other tech heavyweights like Tesla and AMD offsetting the much more prevalent flat returns and small losses on the right side of the bell curve.
Artificial intelligence innovations doubtlessly pushed some heavy hitters higher, particularly firms like Nvidia and AMD, but other companies gained investor trust through operational cutbacks and debt reduction measures.
But And oil and gas stocks took one of the heaviest beatings this year.
Oil and Gas Markets in 2023
Volatility and uncertainty marked global markets in 2023, but the oil and gas (O&G) industry proved particularly sensitive.
Source: OPEC Monthly Oil Market Report – May 2023
2023 thus far saw growth flat in many key countries and even declining in some regions. Facing weakened demand across the board, OPEC nation-states reacted to collapsing per-barrel pricing with surprise production cuts to keep energy pricing competitive with inflation.
In April 2023, member states announced a 1.16 million barrels a day slash for May that did little to improve pricing prospects as the Brent crude price index remained stagnant around the $75 - $80 range:
Source: MarketWatch
During OPEC’s upcoming June 4th, 2023, member state meeting, analysts predict further production reductions due to the failed price pump.
Tortoise Pipeline and Energy Fund managing director summed up institutional sentiment and expectations on June 1st when he told MarketWatch, “Saudi Arabia is frustrated that crude-oil prices are not higher, especially after the surprise announcement of a production cut in April […] we think Saudi Arabia wants to keep the market guessing.”
A Prisoner’s Dilemma
As is abundantly clear down to the consumer level, ongoing conflict throughout Eastern Europe caused sanctions and price caps. It led to a supply crunch that set global markets askew and prices skyrocketing for distributors and retailers alike.
Ultimately, much of the O&G industry seems engaged in a multinational prisoner's dilemma, with each organization and state trying to guess what the other is thinking in a bid to position best their own output, production, and export income.
With the global game of chicken ongoing, it's little wonder many United States O&G stocks suffered mightily in May despite overall market improvements.
“Ouching” Imminent?
But valuations in these slashed stock prices may mean they're simply on sale for optimistic traders echoing the Saudi Arabian energy minister's sentiment against short sellers and bearish speculators in anticipation of an imminent rally: "I keep advising them that they will be ouching, they did ouch in April, I don't have to show my cards I'm not a poker player [...] but I would just tell them watch out."
Energy Selector Sector SPDR ETF (XLE)
YTD Growth: -12.44%
Source: Morningstar
As with most investments, beating a well-managed ETF is hard if you’re bullish on a particular sector. ETFs help capture industry upside while managing the company-specific systematic risk that comes with independently developing a portfolio.
If you’re hot for oil stocks, XLE could be your preferred pick. XLE replicates the Energy Select Sector Index, which comprises all energy stocks within the S&P 500 index.
If you prefer going it alone, some specific stocks on sale right now are perfect for a burgeoning O&G portfolio.
Occidental Petroleum Corp (OXY)
YTD Growth: -8.46%
Source: Morningstar
Occidental Petroleum (OXY) is a retail investor favorite that's been capturing institutional attention lately as Oracle of Omaha legend Warren Buffet continues accumulating shares in the company. Buying the dip all year, he holds 222 million shares as of May 31st, representing a $13B investment in OXY. That's nearly a 25% stake in the company, so Buffett is clearly bullish on OXY despite O&G's woes.
The company is dominant in the US' primary production zone, the Permian Basin, ensuring continued market capture as the company maintains a stronghold in the oil-rich fields. More importantly, its executive team continues a track record of managerial success despite market setbacks.
Production beat optimistic estimates by 2% in the most recent quarter, and consistent spending levels below $6B which contribute to its hefty 24.58% TTM net margin compared to the industry-wide 16.30% average and 22.34% ROIC over the industry's 17.63. OXY is definitely not a value trap, as we see across other sectors, and Buffett agrees!
Devon Energy Corp (DVN)
YTD Growth: -25.05%
Source: Morningstar
Income investors will be drawn like moths to a flame when they see Devon Energy Corp’s (DVN) substantial 10.82% dividend yield. However, O&G bulls can also take advantage of the decent dividends to generate cash flow or dollar-cost average further with reinvestment.
Devon represents a major player in some of the States’ lesser-yielding fields, like the Powder River Basin. Still, its entrenched in those areas and expects operational performance to continue along current lines. This means Devon has limited growth opportunities, as management referenced in a recent press release.
Still, continued free cash flow generation and a commitment to return value to shareholders (including a $3B buyback program) mean DVN represents a quality opportunity to collect cash while waiting on a rebound, if not a long-term investment in its own right, considering its limited expansion chances
Conclusion
Amid global economic unpredictability, oil and gas stocks offer an alluring prospect for astute investors recognizing opportunity in value in adversity. These stocks, beaten down by external pressures, are primed for a rebound but taking a position in oil now necessarily means going against the crowd and short-term momentum.
