When Will the Oil Bath End?
This market has been painful. I have been mainly bullish on oil because of the supply dynamics, and I have underestimated the degree of demand destruction that a recession can bring. I really did think that oil prices could remain high even if the rest of the economy was slowing. It has been scary watching how quickly entire economies are unravelling, not to mention its stock markets! It's been difficult to keep a level head as you see your capital evaporate, but I've been trying to focus on some investing principles.
Buying around the bottom is as good as you're going to get. Timing the actual bottom is probably luck.
Buy companies with little debt. Even blue chip GE is suffering because of the huge amount of short term commercial paper that it needs to roll over.
Buy companies that make essentials. This has been covered with our previous investment in consumer staples as opposed to more luxury items. I believe energy companies and oil service companies fit the bill here too!
Buy the long term trends. This one I have found difficult to use investment wise. For example, the demographics of the baby boomers suggests that nursing homes and funeral homes will become big industries in the future but this is not easily investable in the near to medium term. Even the price of oil is long term upwards, but that doesn't mean that oil is a buy now!
Having said all this I believe that oil service companies are good investments today. Most are trading in the low single digit forward P/E range, and many have backlogs of orders that extend out further than the next oil cycle.
There was a good article in the FT today about the world's oil fields maturing faster than anticipated. The higher decline rates approach 9% without reinvestment and will still be 6.4% with massive investment. All this required reinvestment bodes well for the long term fundamentals of oil service companies. I find it hard to believe that a recession can cause demand destruction of 6.4% a year. (only a depression of historic proportions could decrease energy use by 6% a year!) The article cited that any slow down in oil field reinvestment would eventually magnify the decline of oil flows!
I won't give any price predictions for oil as my recent track record has been weak! It will be interesting, however to see where the price of oil eventually levels out, as everything has been sold off in this great global credit unwind.
posted by Des @ 10/28/2008 08:52:00 PM
1 Comments:
Just as the overshoot to $147 had little to do with oil fundamentals, I suspect the undershoot will have little to do with demand/supply dynamics. I mentioned to Arash several times, during the oil bubble of 2008, how oil stocks traded inversely to the rest of the market. On the up days for oil, the rest of the stock market traded lower. This seemed counter-intuitive since strong economy (markets) begets higher oil demand, and vice-a-versa.
In hindsight, I recall a similar market dynamic during the peak of the dot.com bubble. When the Nasdaq moved up the rest of the Dow moved lower. It was kind of hard to see since the Dow included MSFT and INTC and IBM.
In effect, the money was moving from the rest of the market to the bubble assets! If history is any guide, and having lived through the dot.com crash, I think oil has a long way to go! If you look at the above 3 tech names over they past 8 years, they have traded at very modest valuations despite their growing profits. Having said that, there have been winners and loser in the tech sector since then. Some great companies like AAPL, RIMM, and GOOG have emerged from this tech rubble. This has taught me, investing in former bubble sectors is very hard. You have to be very selective in the companies you keep. The fast money has moved on and they will be very adverse to paying a premium again for these stocks that just burned them. I think there is short term money to be made in the bounces, but sell into the rallies. I agree the long term trend for oil is up, but we may see valuation contraction.
Just as profits for MSFT, INTC, and IBM have been growing over the past decade, you would have lost money if you've bought those stocks 7 years ago, post-bubble.
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