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Oil Company Prospects – Essential Products And Bargain Priced Stocks

Past performance makes oil stocks look like a terrible investment. Look to the future, and oil companies appear to have, well, no future. Worse, they are not “E” – The leading criterion in “sustainable” investing’s ESG acronym (Environmental, Social, and Corporate governance).

As a result, some major pension and foundation funds are announcing new investment policies that remove oil company stocks from their lists of permitted holdings. Even Barron’s is leaving oil companies out of their 2021 stock picks after their 2020 pick, Royal Dutch Shell, bombed.

So – What should we do? Avoid oil company stocks because they are under-performers, irrelevant to the world’s future, or just plain bad actors?

No. We should view them as we would any company whose business line’s heyday is past: Treat it as a “cash cow.” That consulting term encapsulates the proper classification and treatment of a profitable division with stagnant or declining demand.

This is the position oil companies are in now – providing a needed global source of energy, but with declining demand.

Think of oil this way: It is an necessary product that we wish wasn’t. That means the oil companies are necessary, too. Likewise, running an oil company, working for an oil company, or being an oil company shareholder are necessary roles.

Therefore, avoid labeling oil companies as culprits in this global warming period. Instead, focus on the cure to the problem. It has three parts:

  • First, increase “clean” sources of energy to replace fossil fuel, as is being done now
  • Second, decrease energy usage through product enhancements (e.g., higher MPG requirements on new gasoline-powered vehicles)
  • Third, decrease energy usage through consumers and users taking energy reduction actions

That third part is not getting much press nowadays. No one wants to label energy consumers as the problem. And yet, they offer the quickest and easiest solution. (More about how this solution worked in the 1970s at the end of this article.)

Now, on to buying oil stocks

Having decided to invest in oil companies (or, more generally, natural resource firms), which one is best? There are three reasons to avoid this question:

  • First, no one natural resource company can be “best.” All the leaders own desirable assets, rights and operations that make them effective.
  • Second, natural resources are bought and sold in world markets. Therefore, individual companies possess little pricing power, cost control, or branding superiority.
  • Third, diversification among the leaders is especially beneficial in a sector/industry where winners are tightly grouped and “accidents” by one company can produce huge, negative returns (think BP’s Deepwater Horizon explosion).
    Therefore, focus on a natural resources fund

As an example, consider the Adams Natural Resources Fund. This is a closed-end fund that focuses on natural resource companies with a heavy weighting in the oils.

Importantly, closed-end fund investors make share purchases and sales in the stock market, not directly with the fund. The benefit to the fund managers is that they can maintain their positions in the fund without having to react to daily inflows and outflows.

However, that also means the share price in the market can differ from the fund’s actual NAV (net asset value per share). And that can mean the shares sell at a discount, particularly when the fund has underperformed. This is the fund’s situation currently.

At the market’s close on December 30, the fund’s NAV per share was $13.83, and the price was $11.45. Therefore, a buyer could acquire the shares at a 17.2% discount to their NAV. The importance of that discount is twofold:

First, since distributions of dividends and capital gains are paid out of NAV, they represent a higher percentage return on the lower share price. For example, a 5% distribution from the fund (equal to $0.6915 per share) is a 6.04% return to the shareholder.
Second, this fund’s discount is large and associated with a lengthy underperformance. Therefore, improved fund performance could attract buyers, thereby driving the price up faster than the NAV and causing the discount to shrink. That is a bonus return.

Electric vehicles – A solution that will take time

Nowadays, any discussion of oil naturally turns to electric vehicles. So, let’s discuss that next.

Certainly, it looks like a flood of electric vehicles is coming, aided by government mandates requiring most new vehicles powered by electricity in the future. But wait…

Even if electric vehicles are the only models on the showroom floor, that doesn’t mean the previous gasoline-powered models will be scrapped. Instead, it takes time to make such a shift – a long time. And that means oil will still be a needed as an energy source for vehicles.

A good example of the lengthy time lag is when lead was removed from gasoline. Gas stations had to continue selling leaded gas for years because older engines would knock and ping without the lead additive. Although unleaded gas was universally available in 1975, it wasn’t until 1996 that leaded gasoline finally could be banned.

The bottom line: Gasoline-powered vehicles will be around for years, so oil companies remain a necessary industry

We can have it both ways: Moving to a cleaner future, with oil companies providing a positive contribution during the transition.

Addendum: How consumers helped alleviate the 1970s energy crisis woes

In the mid-1970s, when the sudden OPEC oil crisis (high prices and rationing) hit the U.S., decreasing energy usage became a necessity, and people reacted positively. Heating and air-conditioning temperatures were adjusted; lightbulb wattages were reduced; fewer lights were used in offices; carpooling became popular; and small Japanese cars with high MPG ratings became the rage. This consumer focus led to helpful energy ratings for appliances and mandated MPG improvements for new cars.

A word about that MPG mandate by the EPA. General Motors recently gave up its battle against California’s future MPG requirements. Given past results, that was a wise move. Higher MPGs have been good for car companies, including GM GM -0.5%.

For example, in 1978, GM came out with its new line of fuel-efficient vehicles that, overall, met the EPA-mandated higher MPG ratings. As a result, their sales took off after years of taking a beating from Japanese competitors.

My example from that time shows why GM won. I traded in my 1967 Chevrolet Malibu 2-door sedan with 12 MPG (on the highway) for a 1978 Chevrolet Impala station wagon with 18 MPG. Doing so upgraded my car size while reducing my gas usage by one-third – from 1-1/2 gallons to 1 gallon per 18 miles. (Updating to today: I drive a 2015 VW Passat that gets a consistent 36 MPG on the highway)
Source: Forbes

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