With the decline of the Brent crude oil price over the past year, one of the most common questions I have been receiving is how to play this development.
Over the past few years we have seen oil trade above $120s to the recent depths below $30.
While there are admittedly far more ways than one to skin a cat, I boil this down to two separate ways to consider the issue.
Table of Contents
As an Investor
Thinking about oil first as an investor, I haven’t felt compelled to give much credence to this because commodities are inherently volatile. Oil, for instance, does not have earnings or anything from which to reliably estimate its fair or future value. Without any reasonable basis to determine oil’s true worth, it is difficult to estimate whether oil at $30 is a bargain since there are so many macro factors at play impacting this.
Certainly not the least of the macro factors is the Organization of the Petroleum Exporting Countries (OPEC), which seems to hold most of the cards in this equation. This cartel is certainly worth reading up on to get a handle on just how much control they have over the global oil market. Since they have the ability to arbitrarily decide whether to cut supply or flood the market, oil’s price will always be highly manipulated, leaving the future value for us on the ground to be mere guesswork and hunches.
At this stage, my hunch tells me OPEC wants to wage a protracted war in order to break the back of their North American/global competitors. This could last a fair amount of time–years even–and cause many otherwise healthy companies in the industry to die off, leaving less competition when prices are driven up once more.
Another problem with investing in oil is that investing directly in the commodity does not provide cash flow. Our favourite form on this site is the passive stream of income we receive from dividends. For my money, the only viable way to seek a dividend stream would be through purchasing high quality companies in the industry that pay a “safe” dividend. While at this point I am holding off in favour of investing elsewhere, I have my eye on Exxon Mobil Corporation (XOM) from the U.S. side along with Suncor Energy Inc. (SU) and Imperial Oil Limited (IMO) on the Canadian markets.
Still, these companies have not seen their share prices be punished anywhere near the level the price of oil itself has. As such, I don’t view them as bargains at this time and will continue putting money elsewhere until such time as I feel there is value to be had.
With the above having been noted, this current drop in price does make things interesting. I suspect things may get “worse” before the price of oil will see any sustained resurgence (no, this is not an endorsement to short oil’s price). As such, I am more than happy to let oil continue to decline. While I have little doubt we will eventually see oil back well above $100 for a barrel, I am not seeking to gamble unnecessarily. I’d rather be patient.
In the mid-teens, I would consider initiating a position in the commodity. I plan to start averaging down into a position at ~$15. If oil never goes this low, no harm and no foul. I don’t feel any pressure to go out of my way to chase an investment in this sector. I simply see an opportunity developing and am getting my plan in place. By establishing a target-buy range, I will be able to discipline myself from buying in too early. In the meantime, I haven’t wasted my efforts reading the prognostications of oil forecasters. They know no more than anyone else about what the future holds.
Now, supposing I get my wish and oil hits $15. I would start building a position, likely within my Tax-Free Savings Account (TFSA) so that any capital gains would be free of the tax-man. Not getting too far ahead of myself, I would not liquidate that position until achieving at least a two-bagger and selling around half to get my investment back out to let the rest ride. This is in a perfect-world scenario, of course. Nevertheless, I would not sell my investment at any point for less than a two-bagger. That’s the benefit of having money to invest that you don’t need for anyone reason in the near-term. Again, patience is a virtue.
How To Invest
While there are a number of ways to invest in oil, the best path for me as a relatively small retail investor will likely be through an ETF if I am able to find a good low cost option.
I haven’t started digging around to find my best choice yet since oil is still far above my target price. However, if and when I feel a bit more urgency if oil continues heading south, I will be sure to post an update as to what I do decide.
As a Consumer
This section I can keep relatively brief given the simplicity.
The bottom line is that having oil at low levels is a blessing for anyone who has to purchase products with oil as a key input. Namely, if you drive a car and pay for your fuel, low oil prices are a direct benefit to you.
I haven’t seen gas prices this low in years and I’ve been topping up my vehicle any time the price has seemed low. Don’t take for granted that prices will stay this way and be aware that the price oscillations will continue to be unpredictable and often quite substantial.
Enjoy it while it lasts.
Conclusion
While the world panics about falling oil prices, be sure to make the most of the extra disposable income you’ll have from lower prices at the pump.
Warren Buffett has oft reminded us to be greedy when others are fearful and this is precisely the tact I’ll be taking here. If I get my way and oil drops below $20, I’ll be looking to make the most of a timely situation.
As a disclaimer, I should add that how I invest is not necessarily how you should invest. My risk tolerance and timelines are sure to be different than yours. Make sure that whatever you do fits your objectives. If you have any questions or concerns about investing, please consult a professional.
Thank you.
– Ryan
How do you plan to take advantage of oil’s decline?
Full Disclosure: No position in any of the stocks mentioned and no intention to initiate a position within the next 72 hours.
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