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It’s been a dicey time for energy investors. The unexpected crash in oil prices sent energy stocks into a tizzy. How are you supposed to react to this situation, especially considering that energy stocks are essential for any long-term diversified portfolio, and account for important sources of dividends for retirement investors?
First, we have to understand how supply and demand are interacting.
With oil prices low, the producers don’t want to just sell the oil into the market. That’s because they are getting paid at half the rate they were a few months ago. So they jam all that inventory into holding tanks.
Meanwhile, production continues in the Middle East, driving up supply all the more. Demand has been relatively stable. Then, because the dollar is strong, it makes purchasing oil all the more expensive for foreign buyers.
The concern, then, is that eventually supply can no longer be held and has to be sold. More supply floods the market, driving the price lower. So some analysts think that already low oil prices will continue to fall.
What’s an investor to do?
First, energy remains a must-own. If anything, you have a chance to get in at lower prices today than last year. So you can get started by opening some positions, but only open partial positions in case you need to average down.
How far could oil prices and oil stocks fall? If we look to 2008, the last time oil hit a big crash, we might get some guidelines. You may recall that oil went parabolic, then came crashing down to earth by almost 80%.
In 2008, ExxonMobil (NYSE: XOM) fell a total of 41%. It is presently down 20%. I like ExxonMobil for several reasons. Fourth quarter net income was $5.6 billion. Operational cash flow was $7.45 billion. These are great numbers, even in an oil price decline.
If oil prices fall to something like $30, for a total decline of 70%, then you can buy right here to start a position, and look to add more every five or 10 points down.
Chevron Corp. (NYSE: CVX) fell 47% from top to bottom. It is presently down 25% from its high. I think you can open a position here as well, and add every $7-$8 down from this point.
ConocoPhillips (NYSE: COP) fell from $72 all the way to $26 in 2008, a decline of 65%. It’s off 28% so far. I don’t really love the company’s positioning quite as much, so I would suggest waiting until the stock falls into the 40s before getting involved.
On the other hand, there are two other ways to handle this. The first is to do what I did, which is to open a half position in the Energy Select SPDR ETF (NYSE: XLE), a fund consisting of all the energy names. The XLE fell 58% in 2008, and right now is only off 25%. It has held up remarkably well.
The other way to go is to invest in something that is one step removed from energy which should benefit from lower oil prices: transportation. You can do what I did here, which is to buy the iShares Dow Jones Transportation Average (NYSE: IYT).
Cheap Oil Here to Stay – For Now
Crude hasn’t been this cheap since March 11, 2009. And it’s likely to stay low for a while. OPEC refuses to cut production. And US production is expected to increase – not decrease – an additional 600,000 more barrels a day. The Saudis have played this one wrong – and you could profit from their blunder.
Top analyst Tyler Laundon’s found what he considers the best way to play this new, cheap oil boom.