Oil stocks: share prices in this hated sector are back at their Covid-19 lows – time to buy?

Demand for oil plummeted as the world locked itself down, and oil producers’ share prices remain stuck at rock bottom. John Stepek explains why the sector is so disliked, and asks: is it time for a contrarian punt?

Contrarian investors pride themselves in buying sectors and companies that everyone else hates.

That’s the idea, at least. But it’s a lot easier said than done, because when everyone hates a sector, there’s usually a very convincing reason for it.

And yet, there’s one particular sector in the market that seems to be gaining even more hate than is justified right now.

Why are oil prices so low?

In March this year, the share price of Royal Dutch Shell slid below £10 a pop. Back then, Shell was yet to cut its dividend, giving it a yield well into double-digit territory.

Now, Shell’s share price is back below £10. The absolute dividend payout is a lot smaller, having been cut by about two-thirds back in April – the first such cut since World War II. And yet it still yields around 6%.

That’s quite extraordinary. It’s the same story for BP. And for Exxon Mobil in the US.

There are plenty of individual stocks around whose share prices are near or even below their initial Covid-19 lows. That’s no surprise. The market is sorting the survivors from the stragglers and the latest lockdown wave is going to prove the death knell for at least some of the latter.

But we’re talking an entire sector here; the only sector that comes anywhere close in terms of universal investor loathing is the banking sector.

So what’s going on? There are two main issues here.

Right now we have a bit of a bull market in “green” tech and ESG investing (that is, investing with environmental, social and governance issues in mind). Everyone is talking about an electric vehicle led, low carbon future. So your old school fossil fuel stocks are out on their ears, and the hot young solar and hydrogen stocks are having a ball.

Does this make sense?

Are we going to move away from fossil fuels in the long run? It’s the goal. It appears to be achievable as long as we’re willing to throw enough money and time at it. So in the long run, I think the answer is probably “yes”. And I imagine most of us would welcome that.

Is it likely to happen as quickly as the market now thinks? That’s where I am more sceptical. You only need to look at the dotcom bubble to see how markets can get their timing wrong when they’re gripped by enthusiasm.

The internet did change the world, and it did completely upturn many industries in ways that only the most wide-eyed optimists foretold in the late 1990s. But even although the optimists were right, the valuations were still wrong.

There may be a future utopia in which we all drive (or are driven around by) hydrogen or lithium-fuelled cars, and all of our electricity comes from wind power (in the UK) or solar power (in nicer climes). Oh, and we don’t use any plastic and we live in peace with the turtles.

But between now and utopia, we still have to get from A to B and we still have to use plastic. So even if oil demand drops, it’s not going to vanish. And that’s assuming we even reach utopia – there’s a lot of global co-operation baked into that assumption and a glance around the world right now will tell you how realistic that is.

How ethical investing could drive oil prices higher

Anyway – while that’s all very interesting, it’s also a bit of a red herring. The scale of the present collapse has very little to do with the rise of ESG, or hopes that we’ll all be driving electric cars in future.

Oil prices collapsed in March and April for the same reason that everything else collapsed: everyone and everything stopped moving. You don’t need oil if you’re not driving and you’re not flying. It’s that simple.

On top of that, you had a price war between Saudi Arabia and Russia. That’s since been called off, but that’s what drove prices to their absolute nadir.

The question then is: what’s going to pull oil prices back up? Because that’s the only thing that will provide more hope for the share prices of the downtrodden oil majors.

There are two obvious answers. On the demand side, we need the global economy to open back up. That’s happening, albeit slowly. On the supply side, we need oil producers to produce less oil.

And this is where the “green” bubble side of things comes back in. It’s easy to be cynical about ESG, because many companies use it in a cynical manner. “Greenwashing” – talking up your environmental commitments purely for PR purposes – is rife.

But sometimes these behavioural shifts can have a real impact. JP Morgan is the biggest lender to US shale oil companies. The bank is now saying that it’s going to rein in its lending to fossil fuel producers.

Now, ESG might just be a good excuse to pull loans to companies that have never and will never make a profit. But whatever the reason, if shale producers have their credit lifelines yanked away from them, then US oil production can’t help but fall. And if that happens then supply could take a big hit.

Will it happen soon enough to drive oil prices higher? I don’t know. But what I do know is that the sector is deeply disliked, which suggests that the market is overly gloomy rather than overly upbeat. In turn, that means it’ll be easier for expectations to be beaten to the upside rather than the downside.

In short, I’d rather be long the oil companies than short them right now. And if you don’t fancy doing a lot of research into individual oil companies, something as simple as a FTSE 100 tracker or fund will get you a decent amount of exposure to oil as well as a lot of equally hated bank stocks.

We wrote about oil and the green future (and more specific ways to invest in both) in a recent issue of MoneyWeek magazine. If you’re not already a subscriber, get your first six issues free here.

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