Should You Invest in Oil?
Investing in oil today might seem like the ultimate contrarian play for stock pickers, but that hasn’t always been the case. Share prices in oil companies like BP, Shell, and Chevron soared during the oil boom of the early 2000s. When oil prices peaked at $165 per barrel in 2008, oil giant ExxonMobil was the most valuable company in the world.
Oil prices crashed to $50 per barrel during the financial crisis before enjoying another “mini-boom” that kept oil companies, and their investors, making big bucks for the next five years.
The party ended in 2014 and oil prices have been in a free fall ever since. Investors who saw an opportunity to invest in oil stocks or ETFs at rock bottom prices have largely not been rewarded. How bad have the past five years been for oil investors?
The iShares S&P/TSX Capped Energy Index ETF (XEG) holds the 22 largest oil companies in Canada. In the five years ending April 8, 2020 XEG has lost an incredible 72%. Compare that to the broader TSX/S&P Composite Index, which is down just 9.8% in the same time period.
That certainly paints a bleak picture for oil investors. And while we know that climate change and green energy initiatives will continue to have a negative impact on the oil and gas sector, we also know that the demand for oil has not peaked and will not for many years to come.
So, if oil prices have bottomed and have nowhere to go but up, how can a contrarian investor take advantage of the recovery? Let’s look at some ways to invest in oil.
Oil Investing Options
Investors have several options to consider when investing in oil. First, we’ll look at individual stocks in Canada. Those include stocks paying high dividend yields, or stocks with low price to earnings ratios.
Oil Stocks with High Dividend Yield
Many oil stocks pay dividends and, with stock prices beaten up over the past several years, their dividend yields can be incredibly attractive. Here are the top high dividend yield oil stocks in Canada:
Company Ticker Dividend Yield % Pembina Pipeline Corp TSX: PPL-T 9.15 Canadian Natural Resources TSX: CNQ-T 9.11 Enbridge Inc TSX: ENB-T 8.23 Suncor Energy Inc TSX: SU-T 8.08
A word of caution. Chasing high dividend yielding stocks can come back to haunt investors if the company chooses to reduce, suspend, or eliminate its dividends. These cost cutting moves often take share prices down with them.
Oil Stocks with Low Price-to-Earnings
A safer bet might be to look at investing in oil stocks whose price-to-earnings ratio have fallen. These stocks may or may not pay a dividend, so investors would be betting on share prices returning to their former oil-boom glory:
Company Ticker Price/Earnings Cenovus Energy Inc TSX: CVE-T 2.16 Canadian Natural Resources TSX: CNQ-T 4.11 Imperial Oil TSX: IMO-T 5.94 Inter Pipeline Ltd TSX: IPL-T 7.08
The price-to-earnings ratio matters because it provides a measuring stick to compare whether a stock is overvalued or undervalued. A low price-to-earnings ratio could indicate that the current stock price is low relative to earnings. Value investors can use the P/E ratio to help find undervalued stocks.
How To Invest In Oil With Little Money
While I don’t advocate picking individual stocks, I can’t begrudge an investor who wants to allocate a small portion of his or her portfolio to betting on certain companies or sectors. It’s certainly not impossible to imagine a future where oil prices return to their previous highs and an investor can take advantage of the recovery. Just remember not to put all your eggs in one basket.
Let’s say you want to take 5% of your portfolio and invest in oil stocks. How should you invest in oil with little money? Rather than picking one or two individual stocks, the smart play would be to invest in an ETF that tracks the Oil & Gas sector. A few options:
- XEG: This iShares ETF aims to track the performance of the S&P/TSX Capped Energy Index. If you want to invest in Canadian energy, this isn’t a bad way to do it. As mentioned, this ETF has been beaten up over the past five years, but still has net assets of more than $426M. XEG also pays an attractive distribution of 5.63%, or 6 cents per share. It comes with a total management expense ratio of 0.61%, which is expensive compared to broad market ETFs but a reasonably cheap way to invest in 22 Canadian oil and gas companies with just one fund.
- BMO’s Equal Weight Oil & Gas Index ETF (ZEO): This ETF holds 11 large-cap oil companies using an equal weighted approach, rather than XEG’s market-capitalization weighting. It comes with the same MER of 0.61%. ZEO’s concentrated approach has led to better returns than XEG, but it’s still down 66% over the past five years.
- iShares MSCI Global Energy Producers ETF (FILL): This global energy investment tracks oil and gas companies listed in both developed and emerging markets. It has 202 holdings and has outperformed the Canadian oil ETFs by a wide margin (still down 49% over five years). The MER is just 0.31%.
If you’re a first-time investor, you may be wondering how to buy stocks. The best way to invest in these oil ETFs is to open a self-directed investing account and build your own portfolio at Questrade – which ranks as our top online brokerage and offers free ETF purchases. A bonus: Young and Thrifty readers who open a Questrade account get $50 in free trades. Or try out Wealthsimple Trade – a mobile-trading platform that offers zero-commission stock and ETF trading. Plus, you can take advantage of our exclusive promo offer: open a new Wealthsimple Trade account, and get a $10 cash bonus + $0 commission trades. All you have to do is deposit $100 and buy $100 worth of stock within the first 45 days.
Whichever you choose, either route will save you loads on money on fees and is an excellent way to start investing.
How to Invest in Oil Futures
When I think of trading commodities futures, I can’t help but recall the 1983 classic movie, Trading Places, with Eddie Murphy and Dan Aykroyd betting on the price of oranges while trying to corner the market on frozen concentrated orange juice. Hilarity ensues.
You’re not likely to corner the oil market, but you can make a play on oil prices by investing in an oil futures ETF. Investors need to be careful when trading commodity ETFs because prices can swing wildly. The ETF’s attempt to track the benchmark will be imperfect, and during periods of intense volatility, the ETF may lose track of the benchmark because it is really buying future contracts and not the commodity (a barrel of oil) itself.
Horizons NYMEX Crude Oil ETF (HUC) tracks the performance of NYMEX light sweet crude oil futures contracts. It comes with a MER of 0.87%.
There’s also the United States Oil Fund LP (USO), which tracks the West Texas Intermediate (WTI) benchmark. Its MER is 0.79%.
Finally, investors looking to track Canadian crude oil futures can look to the Auspice Canadian Crude Oil Index ETF (CCX), which comes with a MER of 0.65%.
Investing in oil right now is a true contrarian play. Prices had been decimated for five years. Then along came a price war between Saudi Arabia and Russia that further deteriorated the North American market.
Still, it’s not out of the realm of possibility that we’ll see another oil boom in our lifetime. Those who invest now, with prices depressed by 60-70% might be poised for major gains.
Whether you’re investing in individual oil stocks, oil and gas ETFs, or making a play on oil futures, just know that you’re taking a major risk by betting on an industry that’s currently on life support.
Not sure if oil stocks are for you? Broaden your horizons and check out The Best ETFs in Canada and The Best Investments in Canada. That’ll give you a hefty portion of food for thought when it comes to building a balanced, diversified portfolio that works for you.
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