Oil stocks: Investing in oil companies is a slippery business. After plunging nearly 80 per cent in the second half of last year, the price of oil has since rebounded, recouping about half of the fall. But investors holding shares of giants like ExxonMobil or Royal Dutch Shell haven’t seen anything like that appreciation – Exxon is actually trading slightly lower than it did in December. Oil price spikes can push the majors’ shares up, but in the longer term they dampen performance.
Scrappy independents like Anadarko Petroleum and Apache have done better. Both companies’ shares are up over 40 per cent since December. However, the majors have less downside risk when oil prices plunge. Last July oil peaked at $147 per barrel and Exxon shares traded at $83. By the time oil bottomed at $32 a barrel in December, Exxon’s stock had dropped less than 15 per cent. Anadarko’s had halved.
Big companies usually have the resources to hedge against price declines. And they often have refining and chemical businesses that enjoy wider margins when oil prices fall.
Other factors act to decouple oil’s performance from the majors’ stock prices. Since the late nineteenth century, production agreements between countries and oil companies have increasingly favoured the former. These contracts often feature sliding scales that allow the host government to capture a greater percentage of revenues as the price of oil rises.
Also, oil price booms set off waves of exploration, which raise the price of everything needed to produce oil, from geophysicists’ salaries to drill bits. If oil prices remain elevated, these effects are accentuated.
This gives investors good reason to think profits will decline over time if prices remain high. Others may think, based on past booms and busts, that price spikes are ephemeral. In any case, majors’ price-to-earnings multiples tend to come down when oil prices rise.
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Smaller firms are often much riskier, but their share performance better tracks oil’s price.
They tend to have more highly leveraged balance sheets, so a fall in the price of oil can make it difficult for them to service their debt – causing their stock to tank. However, rising prices increase their returns on equity sharply. Investors looking to take a flier on the price of energy may find small is beautiful.