In what has otherwise been a tumultuous year for the oil industry, some good news emerged this week as crude oil prices hit a new 2015 high. Since its $110 per barrel price in June 2014, Brent crude prices have crashed to below $50 per barrel; however, as of Wednesday, Brent crude bucked recent trends and ended the day at $64 per barrel. Unfortunately, this good news came at a cost. Analysts acknowledged that the present rise in oil prices is attributable to a group of former Al-Qaeda militants who seized a Yemen oil terminal (the country has been engaged in civil war for months). Although Yemen is a relatively small oil producer, the terrorist takeover highlights the political and social instabilities that plague the Middle East, a region that acts as the main determinant of oil price volatility.
For some investors, oil’s volatility presents a number of lucrative buying opportunities. The world’s two largest oil companies, specifically Exxon Mobil (XOM) and Royal Dutch Shell (RDS-A), have a combined market capitalization of $567 billion and currently trade at 52-week lows. Smaller, high-growth oil field services companies like Halliburton (HAL) – which engage in hydraulic fracking operations – are also trading near 52-week lows. However, just because these companies appear “cheap” does not necessarily mean that they are failsafe investments, especially when considering short-term risks. Before deciding whether or not to invest in oil stocks, given current international geopolitical factors, investors must first understand the essential fundamentals of the oil sector.
Oil Benchmarks: When indicating the (per barrel) price of crude oil, investors utilize two main benchmarks: Brent Blend and West Texas Intermediate (often abbreviated WTI). Brent crude is extracted from the North Sea, whereas West Texas Intermediate is extracted from American oil wells. The Brent crude index is used to price about ⅔ of all international crude oil, making it the most widespread standard for crude oil valuations. Conversely, West Texas Intermediate is primarily used to price U.S. oil. For an overall indication of oil market health, the two crude oil indicators are combined in the Brent-WTI Spread, which references the difference in price between a barrel of Brent (international) crude and WTI (American) crude. The current Brent-WTI Spread is $5.19, thus indicating that a barrel of Brent crude oil trades at a $5.19 premium relative to a barrel of WTI oil.
Types of Crude Oil: Oil markets contain four main classifications: Light/Heavy and Sweet/Sour. Light/Heavy refers to oil density, while Sweet/Sour refers to oil’s sulfur content; Sweet oil contains less than .5% sulfur, whereas Sour oil is comprised of more than .5% sulfur. The global oil industry prefers Light, Sweet oil because it doesn't require as much time to refine and produce. Both Brent crude and WTI crude are considered light and sweet.
Investing in Oil: Unlike popular securities, Crude oil does not trade as common “stock” on the NYSE or NASDAQ; instead, it is the energy-centric companies that trade on these indices. Crude oil is measured “by the barrel” and sold as a commodity, like gold, lumber, and coffee beans. Commodity markets function differently than the stock market, as the primary method of exchange is through “futures” contracts, rather than buying and selling common company stock. Unlike basic trading practices, commodity contracts relate to the future prices of exchangeable goods. In many ways, for those familiar with short-selling or options trading, “futures” contracts are bets related to future prices of popular commodities. As such, I strongly advise inexperienced investors avoid trading commodities until they are first comfortable with the many current intricacies of the stock market. Unlike securities, commodities experience more price volatility, as they are inextricably linked to global activities. Therefore, amateur investors can, if they so desire, take advantage of the recent upswing in oil prices by investing in energy (or oil) companies.
Oil and Gas Companies: There are numerous publicly-traded oil and gas companies. First and foremost are the “Big Five” international oil companies: Royal Dutch Shell (RDS-A), Exxon Mobil (XOM), British Petroleum (BP), Chevron (CVX), and Total S.A. (TOT). Amazingly, all five companies are among the 15 largest corporations in the world. That said the ongoing drop in gas prices has hit these businesses hard, as their holdings and interests span the globe. The “Big Five’s” international presence has long allowed for massive revenue generation; however, given current worldly affairs, their exposure has proven problematic. Similarly, domestic independent oil companies, such as Valero (VLO) and Tesoro (TSO), which operate refineries and gas stations, have also been impacted (though not to the same extent as bigger players). Thus, if oil prices continue to rise, energy investments may yield the best returns of 2015.