Is Now the Time to Buy Oil Stocks?

Clean energy is rising as the go-to source for powering the world. But it isn’t there yet, which means that oil is still an important part of the global energy supply. What are investors to do with this long-term-versus-short-term dilemma? Here are some things to consider before you make the decision to buy or avoid oil stocks.

Yes, it is time to buy oil

Burning oil generates carbon and contributes to global warming. That’s a fact that can’t be ignored, and one of the main reasons why the world is looking to limit its future use. In October 2020, the International Energy Agency (IEA) stated that growth in oil demand is likely to end by 2030 and then flatline. However, it added, “In the absence of a larger shift in policies, it is still too early to foresee a rapid decline in oil demand.” The main reason for both trends is that demand is still likely to increase in developing markets as they move up the socioeconomic ladder, and oil remains an important feedstock in the chemicals space. In other words, oil is far from dead.

A person in a blue work suit with an oil rig in the background.

Image source: Getty Images.

Oil is a commodity prone to large and often dramatic price swings, so there is always a great deal of volatility in the sector. That’s likely to get worse as the energy sector tries to balance supply and a change in global demand dynamics. But the so-called “invisible hand” of the market is fairly good at getting things to work out over time. That suggests that, at least for now, some caution could be in order until a new normal unfolds. So sticking with large, financially strong oil companies with diversified businesses is probably the best call for most investors. In other words, integrated oil majors like ExxonMobil (NYSE:XOM), Chevron (NYSE:CVX), Royal Dutch Shell (NYSE:RDS.B), and TotalEnergies (NYSE:TTE) are a good starting point. 

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And right now, three of these four energy giants have historically high dividend yields. That suggests that they are relatively cheap today, even after a big run over the past year. Shell’s trailing yield is historically low, but that’s because it cut its dividend as part of a larger plan to increase investment in renewable power. It has, however, gotten back on the dividend growth path again, most recently hiking its payout by 38%. The forward yield of around 4.7%, while still low, remains fairly attractive on an absolute basis. TotalEnergies is going down the same clean-energy transition path, but didn’t cut its dividend, and offers a much higher 7.2% yield.

So far Exxon and Chevron are basically sticking with oil, though they are increasingly under pressure to do more on the clean energy front. Both of their dividend yields fall in between those of Shell and TotalEnergies. That said, eventually, all are likely to end up using cash from the core oil business to adjust with the world around them. If you believe that’s a workable plan and that there’s ample time to make the shift, as the IEA outlooks suggests, then today does look like a decent time to buy oil stocks.

TTE Dividend Yield Chart

TTE Dividend Yield data by YCharts.

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No, it isn’t

That said, there’s an important phrase in the IEA quote above that imposes a major condition on its outlook: “In the absence of a larger shift in policies.” The world is increasingly focused on carbon emissions, and oil is at the center of the conversation. More and more countries are enacting policies to encourage the use of electricity or other cleaner alternatives in areas that are currently dominated by oil, notably including transportation. This is a big unknown, and could derail demand.

There’s anecdotal evidence all around that this is a very real threat, from the rapid growth of the electric car market to airplanes that are powered by electricity. If oil is quickly displaced by electricity with the help of government mandates, like the United Kingdom’s plan to ban gas and diesel cars by 2030 (among others), the energy industry could be in for a tough slog. At the very least, volatility could be higher than normal, and eventually it will be hard to justify owning a publicly traded oil driller. That includes the integrated majors noted above. 

Conservative investors that prefer to err on the side of caution should probably give a great deal of thought to this line of thinking and avoid the oil sector. There are plenty of other areas to put money to work on Wall Street, so why bother making a long-term bet in such an uncertain environment? Cheap or not, the risk and uncertainty probably wouldn’t be worth it.

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The final call

There’s no clear answer here given that so much of oil’s future depends on the shift toward cleaner alternatives. If it is a slow march, as many expect, then oil could be a cash cow for years and help integrated giants transition toward new business lines. If the pace of change speeds up, however, oil could find itself with major supply/demand imbalances that sink the price — and the financial results of the companies that produce it. 

As you decide whether oil is a buy today, the real question is which line of thinking makes the most sense to you. And even if you think oil will see ample demand for years to come, it still makes sense to hedge your bet and stick to the integrated energy giants. They are the companies that are most likely to navigate the changing energy environment with the least amount of pain.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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