Is oil investing safe as the price drops?

Oil investing has become a hit and miss affair, especially given the precipitous decline in oil prices over recent years.

While oil was trading at over $100 a barrel just three years ago, these days traders get excited if the black stuff manages to claw its way above the $50 per barrel mark.

Oil stocks can provide investors with effective exposure, but should investors now steer clear of oil altogether?

Along with the widely cited current glut in the market, there are also longer-term issues hanging over oil, such as the rapid rise of green technology.

Oil worries

When assets are in the doldrums and confidence is low, canny investors can often pick up bargains. Right now, there´s no doubt that oil is up against it.

Last year, OPEC unveiled landmark agreements to cut production, with non-OPEC producers such as Russia also pledging to cut output to boost prices.

But a decent run up in prices, that saw Brent oil futures rally from lows of around $30 per barrel at the beginning of last year to reach $57 per barrel in January 2017, has sputtered to a halt. Oil prices have stumbled year-to-date, with Brent currently trading around the $50 per barrel mark.

OPEC doubt

On the one hand, recent surveys have suggested that OPEC production has been rising of late, casting doubt over the organisation´s ability to make a meaningful dent in output.

There has also been higher production in North America. A revolution in oil drilling methods has seen US output rise, especially in the Texas Permian Basin, where fracking techniques mean US producers can now break even at lower oil prices – well below the $40 per barrel mark.

Then there are the longer-term concerns over the demand outlook. For instance, accelerating take-up of electric cars could weigh on oil prices over the coming decades.

Cautious stance

Big oil companies have been adopting a cautious stance over recent years, with many focusing on cost-cutting and asset sales as they have prepared themselves for oil prices to stay in a lower range.

While no one really knows for sure, few expect oil prices to return to the $100 level. Though $70 per barrel has been widely floated as a new possible price peak in the short term, this would assume the industry can quickly emerge from the current supply glut.

In February this year, investment bank Citi predicted oil could reach the $70 per barrel mark by the end of 2017. At that point though, there was also a lot more optimism in the market about OPEC´s ability to rein in output and push up prices.

Good results

That said, second-quarter results from the mega oil companies were generally good as three years of cost-cutting and restructuring efforts enabled some of the big names to beat earnings expectations.

Shell reported $3.6bn in second-quarter profits, a 245% surge versus the year-ago period. Likewise, France-based oil major Total also exceeded second-quarter earnings forecasts, reporting adjusted net income of $2.47bn, 14% higher than the year earlier.

Both companies, however, saw a squeeze on profits versus the first quarter of 2017. Even with the best management in the world, if you´re an oil producer and prices fall, you´re likely to see some decline in the bottom line.

Year-to-date, Brent crude oil futures have eased from around $57 per barrel at the beginning of the year to $52 per barrel today, a fall of 9%.

Correspondingly, Total´s shares have slipped by 10% this year, while Shell´s stock is trading around 2% lower.

Peak oil demand

One of the things that both firms have in common is that they are increasingly gearing up for a point where demand for oil peaks as the world moves further towards greener technology and renewable energy.

Shell has been steadily increasing its focus away from oil towards natural gas, while also raising its investments in renewables. It has promised to reveal new plans before the end of the year to take advantage of booming sales of electric vehicles and further boost its renewables business.

Renewables charge

The company has earmarked $1bn in annual spending on its New Energies unit, which seeks to further the development of biofuels and hydrogen cell technology for use in aviation and shipping.

Total has been among those leading the charge into renewables over recent years following its $1.4bn investment in US solar panel maker SunPower.

Norway´s Statoil, meanwhile, has also been increasingly focusing on renewables, especially with its investments in wind technology.

Oil majors such as Shell talk not of if demand for oil will peak, but when. Shell believes the world´s use of oil could even peak as early as the 2030s, though chief executive Ben Van Beurden labels this as a “very aggressive” scenario.

Political will

European oil companies may well be ahead of their international counterparts in shifting towards a greener future.

There is a strong political will in Europe to adopt more environmentally friendly technologies. Both France and the UK have already pledged to ban sales of conventional fossil-fuelled cars by 2040.

Cutting carbon emissions has also begun to resonate in China, where a smog problem in cities such as Beijing has seen the authorities force taxi firms to switch to electric motors.

Rapid pace

The rapid pace of adoption in electric cars over the past few years has taken many by surprise.

This summer´s launch of Tesla´s Model 3 vehicle, destined to be the first truly mass-market, long-range electric car, underlines the trend. Model 3 has already notched up over 400,000 pre-orders.

Undeniably, things are moving fast. Last month, Volvo made the landmark announcement that it would cease to manufacture cars solely powered by fossil fuels by 2019. Future Volvo models will either be electric or hybrid.

Oil refinery at twilight.

Oil stocks to buy?

By the end of 2016, a sizeable proportion of big oil majors had managed to push their breakeven levels below the $40 per barrel mark. This includes the likes of Exxon, Shell, Conoco, EOG, Chevron, Pioneer and Continental.

Should oil eventually pick up to $70 per barrel, such firms would be on course for a profits bonanza. However, Shell for one has made it known that it is running its business on the assumption that oil may never go much further than the $50 per barrel mark again.

Knowing that the company is also seriously planning for a future where renewables and greener technology take more of a lead should give investors some added peace of mind for the longer term.

No guarantees

Those who invest in oil should remember that nothing is guaranteed. Incredibly, we´ve seen the extremes of $30 and $100 per barrel oil within the space of just a few years.

Stocks that can offer investors some upside when oil prices rise but also some diversification through exposure to natural gas and renewable technology may be preferable to pure oil plays.

Investors should consider the downside risk of investing in oil stocks as well as the upside potential.