Oil shares have never been this cheap – but will they just get even cheaper?

The oil sector is staggeringly cheap. But oil is still one of the most important commodities in the world. John Stepek looks at where energy stocks might go from here.

It’s only been about a week since I last wrote about oil. But I’m finding it fascinating at the moment. Like most value-orientated investors, I just can’t resist constantly returning to a sector that relentlessly gets cheaper and cheaper.

Of course, as many value investors have learned to their cost in the last decade or so, things that are cheap can just carry on that way until they’ve gone all the way to zero (or below, in some cases).

But when you’re talking about a group of companies selling what is still one of the most important commodities in the world – I just can’t help myself.

The oil sector is staggeringly cheap

Louis-Vincent Gave at research group Gavekal has just put out a piece on oil prices. As ever with Gave, it’s extremely interesting. His core point – one we’ll return to in the future – is that oil, the US dollar, and US government debt have all been trading in a tight range since March. Those are all really important prices. If they start to trend properly in one direction or another, then we’ll have a very different investment environment on our hands.

But in this piece he focuses on oil. He looks at both the bearish and the bullish case, but I really just wanted to highlight some of the incredible statistics that are in his piece. He points out that energy stocks are now the smallest sector in the MSCI World index, with a weighting of just 2.48%. That compares to Apple, with a weighting of 4.46%. In other words, Apple by itself is almost twice as significant as the entire listed energy complex.

OK, Apple is the virtual, shiny, ultra-hygienic future into which we are being propelled, while oil is the real-world, gritty, dirty present day that we are apparently leaving behind. But we don’t all run on batteries yet, and even in lockdown some of us need to get from A to B and sometimes even to C. And the latter requires cars and occasionally planes.

So does that disparity in valuation make sense on the fundamentals? Or is it being driven more by an environment that puts little value on the present relative to the future, because of ultra-low interest rates? Is it all part of the “long duration” bubble? I’m guessing it’s the latter.

Meanwhile, for the first time ever, says Gave, “the broad energy industry is trading at below book value.” In other words, companies are trading for less than the value of the assets on their balance sheets.

That’s fascinating and it’s genuinely unprecedented. It’s also only happened this year. For roughly the decade after the financial crisis, the MSCI World energy index traded at around 1.5 to two times book value. Prior to that it was a lot higher – from 1996 to the financial crisis the low was about two and the high above 3.5.

And the fact that oil has proved to be such a poor investment in recent years means that “energy may well be the only major industry in the world today that is genuinely starved of capital.” Investors aren’t willing to pour yet more good money after bad simply to allow oil companies to keep spending too much to get a depreciating asset out of the ground.

As a result, oil production is falling. That doesn’t matter just now because demand has dropped hard. And with countries around the world locking down to varying and confusing degrees all over again, it’s not likely to bounce back sharpish. Yet what happens when it does?

Moreover, as Cris Sholto Heaton points out in the current issue of MoneyWeek, out today, the oil price doesn’t have to be high for oil producers to make money. If the majors are no longer squandering money in the hunt for new oil, and are instead just hunkering down and running down their existing resources – well that could be very profitable indeed. The oil stocks could be like the tobacco stocks were – unpopular, dirty, but absolute cash machines.

There’s probably no rush to dive in to the sector. But it’s something to stay aware of.

We’ve got a big birthday coming up

On the topic of MoneyWeek magazine, before we go today, I wanted to draw your attention to a big birthday we’ve got coming up. At the start of November, MoneyWeek will be 20 years old.

A great deal has changed in the last 20 years – and I’ll admit that capping the past two decades with a global pandemic was not high on the list of things we expected to happen – but we want to focus on what might happen in the next 20.

We’ll be looking at everything from longevity trends to the risk of inflation returning, to the role of cryptocurrencies, to the state of geopolitics in 2040.

And we’d like your help! We’re asking our readers and contributors a set of five specific yes/no questions on events that may or may not occur by 2040. This week we’ve been asking “will gold hit $10,000 an ounce by 2040?” and “will a human being have set foot on the moon as a tourist by 2040?”

We’ll be releasing the full list here over the next two weeks. Send your answers – plus your justifications – for all or any of the questions to 2040@moneyweek.com. We’ll print the best answers in the November 6th issue.

And if you don’t already subscribe – don’t miss it! Sign up now! You get your first six issues absolutely free.


Stockmarkets have a spring in their step

Stockmarkets have a spring in their step

Global stockmarkets have been basking in the post-Covid economic recovery as GDP, retail sales and manufacturing are all on the way back up.
23 Apr 2021
Stockmarkets shrug off turbulence

Stockmarkets shrug off turbulence

Stockmarkets have hit their first bout of turbulence of the year, but most are clinging onto January’s gains.
4 Feb 2021
Things are looking up for income investors as dividend payouts start to rise
Income investing

Things are looking up for income investors as dividend payouts start to rise

UK dividend payouts are ready to grow again, but this crisis has shown why income investors must diversify overseas.
3 May 2021
Three lessons from football’s European Super League disaster

Three lessons from football’s European Super League disaster

Businesses can learn from the failed attempt to create a European Super League, says Matthew Lynn.
2 May 2021

Most Popular

What is hyperinflation and could it happen here?

What is hyperinflation and could it happen here?

The Bank of England has been accused of the kind of money-printing that could lead to Zimbabwe-style hyperinflation. But that's very unlikely to happe…
4 May 2021
Micro-cap stocks: how to get huge returns from tiny firms
Small cap stocks

Micro-cap stocks: how to get huge returns from tiny firms

Micro-cap stocks are often overlooked, but the British market has plenty of them and their potential is massive. Max King picks the best two investmen…
3 May 2021
Copper has hit a ten-year high, but this could just be the start of a huge bull market
Industrial metals

Copper has hit a ten-year high, but this could just be the start of a huge bull market

The price of copper is at its highest for ten years. But supply constraints and a massive rise in demand mean it’s not going to stop there, says Domin…
5 May 2021