Oil Shares Never So Cheap

But still going cheaper...?

 

I FIND OIL fascinating at the moment, writes John Stepek at MoneyWeek magazine.

 

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.

 

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.

 

These 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, 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.