The oil and gas industry has faced several challenges in the past five years, including low oil prices. Despite the industry's challenges and risks, there are interesting oil and gas investing opportunities to explore.
Oil and gas industry market overview
In recent years, oil and gas industry events have resulted in falling prices. However, confidence in the industry has increased lately due in much part to the oil production limit agreement signed by OPEC and non-OPEC countries. Experts believe the growth forecast for the oil and gas industry is good, as growth is increasing at a fast rate.
In Canada, falling oil prices have caused a stall in exploration and production, resulting in a slowdown in capital expenditures. From 2014 to 2018, total capital spending declined by 48% to CA $40 billion. The Canadian Association of Petroleum Producers forecasts a further decline of CA $38 billion in 2019.1 Pipeline constraints, a lack of market diversity and regulatory uncertainties are primarily responsible for stalling investment prospects.
Oil and gas companies have been increasingly focused on managing working capital efficiently. However, according to the recent "Cash in the barrel" report from American Express and EY, as much as CA $30 billion is still trapped on Canadian oil and gas companies' balance sheets.
The Canadian oil and gas industry outlook shows a moderate growth in production according to findings from the International Trade Administration's Canada Country Commercial Guide. The estimated production of crude oil for 2019 is 4.9 million barrels/day. Natural gas production has also been growing, with an estimated 491 million cubic meters in 2019.2
Strategic approach for investment in oil and gas stocks
The oil and gas market offers various opportunities for investors:
- Exploration and production: Land is purchased or leased for drilling, and if oil is found, the payoff can be considerable. Pure exploration companies may be suitable for you if you have a very high tolerance for risk, as these plays are highly speculative.
- Developing: Less speculative than exploration since drilling is done near proven reserves. They hope to generate more value, but there is no guarantee.
- Income: Land is leased or purchased near proven oil and gas reserves to create a stream of revenues often higher than expenses. This is typically viewed as the safest way to get involved in drilling and extraction operations. The risk is that oil will run out faster than expected.
- Services and support: Related services are provided to energy companies, such as transportation, shipping and logistics companies, pipeline companies and refiners. Some of these companies do not depend on rising fuel prices to be profitable. For example, pipelines earn money by charging a fee per barrel cost. They typically earn the same amount regardless of fuel price, as long as demand remains constant.
Here are four specific ways you could consider investing in the oil and gas sector:
- Large-cap stocks: These are the stocks of large oil and gas companies. To manage your risk, you could buy shares in different companies. Large-cap stocks are usually less risky than small-cap stocks. These are usually sought after by long-term investors.
- Small or micro-cap stocks: Small-cap or micro-cap stocks have a potential for higher returns but are often viewed as riskier and less liquid than large-cap stocks. They can be undervalued, but the market might take time to recognize their value. As a result, small-cap stocks are typically earmarked for those interested in long-term investing.
- Mutual funds or Exchange-traded funds (ETFs): Buying mutual funds or ETFs focused on oil and gas is said to be the simplest way to invest in the sector since they are open to a variety of companies, which typically presents less risk than buying single stocks.
An advantage of ETFs over mutual funds is that the investors often pay lower fees and can trade them like stocks. Mutual funds are designed for long-term investors, but some are intended for short-term strategies, such as ETFs that track the price of oil and leveraged ETFs.
- Futures contracts: A futures contract allows investors to buy or sell oil at a specific date at an agreed-upon price. Futures are speculative investments designed for short-term trading. They are perceived to be riskier than other investments since they can expire without any worth.
Risk and returns that come with the oil and gas industry
As with any investments, there are certain risks associated with investing in the oil and gas industry. Here are some of the advantages and risks of oil and gas investing.
- Potential for attractive returns: As the global population grows, the demand for oil and gas is expected to rise. The reduced supply will likely increase prices, as will the potential return on investments.
- Diversification: When oil and gas prices rise, the economy tends to slow down, causing a fall in stocks. But since oil and gas stock prices tend to rise when oil and gas prices rise, they may protect your portfolio against market downturns.
- Political risks: Geopolitical factors have a significant influence on oil and gas prices. Changes in currency valuation, trade policies and tax reforms in the countries where companies operate may explain part of the prices' volatility.
- Volatility: Oil and gas investments can fluctuate sharply.
- Liquidity: Although you can usually sell shares of large companies quickly, you may find it challenging to find a buyer for small business shares. In some cases, like for private companies, you may need to redeem your interest with the company directly.
Before investing in oil and gas, consider the potential risks and take into account your investment horizon and your risk tolerance.
This article is intended for general informational purposes only and does not constitute legal advice or an opinion on any issue. It should not be regarded as comprehensive or a substitute for professional advice.