Falling Oil Prices Presents Opportunity

Matt Thalman - INO.com Contributor - ETFs

With the recent decline in the price of oil, many investors are wondering, where the opportunity is to make money from the decline? As I have stated before, my investing motto is always to keep it simple; which in this case would mean "simply buy oil stocks."

Over the past few months, the price of oil has unexpectedly fallen from over $100 a barrel to the $50 range. Neither economist, market analysts, or oil industry experts saw this decline coming. So I believe it is safe to say that no one, certainly including myself, knows were the price of oil is going in the near future. But with that being said, I think most would agree the use of oil is not going away in the near future. Oil is and will be the most widely used form of energy in the coming years, despite the rise of natural gas, solar or any other form of energy which currently exists.

The fall in the price of oil has caused oil stocks to decline. For example, Exxon Mobile (XOM) is down more than 8% over the past six months while Chevron (CVX) is off by nearly 14%. Smaller players like Anadarko Petroleum (APC) is off by nearly 22% and Pioneer Natural Resources (PXD) is off by 32% as the price of oil has fallen during the second half of the year. These types of declines have been felt throughout the industry.

One of the first and most common antidotes we are taught as investors is "buy low, sell high." When stocks fall, their price is low or at least lower than it was, which means if you believe in the company, or in this case the industry, then now is the time to buy.

Who to Buy

With so much uncertainty about where the price of oil will be in the future, it is difficult to accurately predict which companies will be able to ride out the lower prices. While it is safe to believe that the bigger players such as Exxon and Chevron will be able to withstand low oil prices better than smaller industry players, those companies may not give investors the most bang for their buck. Over the past five years, Exxon is up 38%, which any investor would likely be happy with. On the flip side though, a smaller oil producer such as Pioneer, who may not be able to withstand low oil prices for an extended period of time, is up 217% over the same time frame and is the best performing energy stock in the S&P 500 since 2009.

So how do you know which oil company to pick moving forward? Start by digging into the 10-k's of each company in the industry. Try to figure out what it cost each company to produce a barrel and see at what price level the company is no longer profitable. This will be a time consuming and very tedious process. In most cases, the lost cost producers are going to be the lower growth companies, meaning if the price of oil climbs, your returns will be lower than others due to the lower risk. So in order to get higher returns, you will need to go with the higher cost producers, which leads to a higher amount of risk taking since they could go belly up if oil stays low for a long time.

Clearly the classic risk-reward antidote is at play if you're thinking about cherry picking energy stocks right now. Luckily though, there is another option. Buying an oil ETF will allow you to play the recent decline in oil stocks without taking on more risk than you need to while still providing adequate return if the price of oil rises in the future. ETFs such as the Energy Select Sector SPDR Fund (XLE) or the Vanguard Energy ETF (VDE) will provide both lower risk than buying small oil stocks in case the price of oil continues to fall and higher reward than buying the large oil stocks if the price of oil moves higher.

When to Buy

Once you have decided which ETF to purchase, the only question that remains is "when to buy." Since we don't know where oil is heading, the fear is that if you buy today, you may be trying to catch a falling knife. While that may be true, I would suggest buying in thirds over the next six months.

If you have $9,000 to put into the oil sector ETF, buy $3,000 worth today, another $3,000 in three months from now, and the final $3,000 in six months' time. This way you are averaging your cost basis over a longer period of time, thus protecting yourself from any future declines in the price of oil.

Final Thoughts

One of my favorite Warren Buffett quotes is, "be fearful when others are greedy and greedy when others are fearful." I believe this quote perfectly sums up how investors should be thinking about the oil industry today. Fear has caused oil stocks to fall, which has led to opportunities for those looking.

Matt Thalman
INO.com Contributor - ETFs

Disclosure: This contributor has no positions in any stocks mentioned in this article. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.

12 thoughts on “Falling Oil Prices Presents Opportunity

  1. Polar vortex can happen . Nuclear power and coal plants going off line. LNG buyers want 25 yr contracts. Natural gas historic historic move up can ignite above 10.

  2. Natural gas futures to ignite much higher . Huge short squeeze and move up. We can see LNG go up big . Natural gas above 7 to double digits

  3. Natural to go huge today continuation historic move up. LNG prices to double in a short period can be a blink on eye

  4. Major economic nations are now facing weakened economic outlooks as tumbling oil prices threaten to drop further, due to surge in U.S. crude production. Investors have begun shedding stocks and currencies closely tied to commodity prices amid growing evidence that cheap crude will stick around in 2015.

  5. Well well, you are averaging down, where is your TA skill? Some Elliott Waves reading
    may help. Cheers.

  6. The Saudis are afraid Iran is near to nuclear breakout with the UN and G5 not doing squat to stop it. Cut the oil price and you cut Iran's income and capacity to make a bomb. Sunni/Shiite animosity goes back 1400 years. If Iran gets tired of low oil income they have plenty of terrorist proxies to do something about it. If a few Saudi members of ISIS go back home and start blowing up pipelines and such, oil is going back up. If Israel blows up a few nuclear assets in Iran, Iran likely will make good on their threat to close the Straits of Hormuz. Can you say $200-250 oil. Such black swan events should chill the hearts of speculators if they were considering going short. Sidelines or maybe a few call options on oil stocks? It really is up in the air.

  7. Bad recommendation to buy oil ETFs today because;
    1. We are in the middle of a big adjustment, if you are not a a big big investor, best you can do is stay aside.
    2. We don't know if we are in the bottom , and data shows that prices will recover in a "L" shape not a "V" one, so, stay away there is not urgency.
    3. While agree about the long term opportunity not all boats will float alike.
    4. U.S. will not allow that main force of American economy recuperation disappear to become again hostages of Arabian oil, what measures will be taken and how and who will affect is the important question now.
    5. Oil market is the most complicated of all, many global events affects, when to be fearful and when greedy here is not an obvious statement, otherwise you can't explain why prices crashes 50% when the clear surplus is around 1% of global 92 million barrels per day.....so be greedy in the right time.

  8. We know why oil, gold, and silver fell around July 1st and with expectations that ECB will start QE next month and the FR start rate hikes next summer we can assume the fall to continue unless Arabia decides to halt it like in 2000 with a production cut that will spike oil, then fall back down as Russia, Iran, and Venezuela cheat on quotas because they lack the financial flexibility to ride out a production cut.

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