Questions to ask yourself before you invest in oil

Oil prices have been skyrocketing until they recently plunged in a bear market, falling almost 30% from June, to now sitting just shy of $90 a barrel.

Despite this sharp pull back, oil stocks all over the world are still some of the best performers this year, supported higher by growing earnings.

Cast your mind back to just two years ago. The oil price plunged to US$20 a barrel, thanks in part to coronavirus and a bruising price war.

But if you simply reflect on where oil was this time last year, it was just $64. So is oil a good buy?

Two things you need to consider before investing in oil

Firstly; Oil has fallen from ~$140 in March to where it is today as China, the world's biggest oil importer and commodity consumer ramped up its COVID restrictions and mass testing and lockdowns.

Recently, one single COVID case shut down one of China's steel hubs for three days. Basically, as long as there are COVID cases, a zero COVID stance, oil remains pressured.

Secondly; Oil's outlook is getting dimmer for consumers and business back pockets, as it's likely to head higher over the longer term. For investors and traders there is opportunity ahead. Why?

Well OPEC suggests global crude demand will exceed supply by 1 million barrels a day next day next year (2023), meaning they see no relief in sight for supply.

This is something at Saxo we've been warning markets of for some time and guided to in our Q3 Outlook.

Investors in Occidental Petroleum (OXY) may be particularly pleased, with shares in that company up 146% since January, while Exxon Mobile (XOM) shares have climbed 28% and Woodside Energy (WDS) is up 52% year to date. If you compare that to the Tech heavy, Nasdaq, it's down 22%, the S&P500 is down 13% and Australia's ASX200 is down 5% year to date.

For years, we've been hearing that that world is about to arrive at "peak oil", and that demand for it will soon drop as green energy sources take over.

While that is true on some accounts, the world has not transitioned in time, so demand for fossil energy will likely grow at a quicker pace until the green world can catch up. It's also worthwhile to note, oil is entrenched in almost every aspect of our daily lives, and this remain the case for at least the next decade.

Oil tends is used for a lot more than just petroleum - energy needs. Petrochemicals, which are made from oil, are crucial ingredients used in society. From being used in the medical industry, to plastics, to food preservatives, cosmetics, glass, carpet, and even fertilizers.

Products that include petrochemicals range from; golf bags, toilet seats, shampoos, crayons, footballs, candles, cameras, and tents, just to name a few. Also consider, even environmentally friendly means of transport, such as bicycles and electric cars used components made of plastic which are made of Petrochemicals.

So yes, whilst there is a shift towards renewables, oil stocks remain a solid long-term investment. The only question is, when is the right time to make it?

As we all saw in 2020, and from 2014-15-when a supply glut flooded the market, the oil market is enormously volatile; with unexpected booms and dramatic busts. So, while Russia's invasion of Ukraine was another catalyst for crude prices soaring this year, a sudden loosening of trade sanctions, or for that matter, a global recession, could case the oil price to fall further and stocks plummet.

So, how should one potentially approach investing in oil?

Questions to ask yourself before you invest in oil

We suggest you ask yourself some questions before investing:

• What is happening in the world?
• Is the situation expected to persist?
• Can the stock weather the storm?

With oil prices being so volatile, the larger players should be better equipped to handle drastic changes in the market. That being said, as the oil price fell almost 30% from June, and some oil stocks fell from their highs, they could also still face further selling before oil demand picks up in China.

Once demand picks up from China (the biggest consumer of oil), then the oil price will likely moving higher again, as oil supply remains critically short and in a deficit.

Therefore, if you are looking to invest in oil, we think it may be best to consider looking at the major players in the oil league like Occidental, Exxon Mobil, Shell, BP, Woodside. Companies like these have strong balance sheets, rising free cash flow and earnings growth, with revenue measured in the billions.

And remember, it can sometimes pay to stick to basics, earnings and cash flow growth drive share price growth.

In a nutshell, as long as oil continues to be an essential part of our daily lives, oil companies should continue to thrive over the longer term.

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