Here’s What Falling Oil Prices Mean for These 3 Energy Stocks
The geopolitical conflict in the Middle East has upended the oil market. Oil prices have risen to $100 per barrel and have been swinging dramatically from day to day, driven by news flow and investor sentiment. This is actually pretty normal for the energy sector, which has a long history of being volatile. If history…
The geopolitical conflict in the Middle East has upended the oil market. Oil prices have risen to $100 per barrel and have been swinging dramatically from day to day, driven by news flow and investor sentiment. This is actually pretty normal for the energy sector, which has a long history of being volatile.
If history is any guide, oil prices will eventually come back down. Here’s what you need to know to prepare for when that time comes.
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Devon Energy(NYSE: DVN) is an independent U.S. onshore oil and natural gas producer. Basically, it drills for oil and gas and sells it. While the company uses hedges to help protect itself from energy price volatility, the core driver of the business remains the prices of the commodities it produces and sells.
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It is effectively leveraged to the price of oil and natural gas. Over the past six months, Devon’s stock has risen around 33%. That’s the upside opportunity with a pure-play energy producer, which is often called an upstream business. Investors should expect Devon Energy’s financial results to be strong so long as oil prices remain high.
However, when oil prices eventually fall, as they always have historically, Devon’s earnings will fall, too. And, as a result, investors will likely dump the stock, leading to a dramatic price decline. Be prepared for a drawdown if you buy Devon Energy while energy prices are rising.
Chevron(NYSE: CVX) is an integrated energy company. It owns production assets, so it is materially impacted by oil price moves. Over the past six months, the stock is up 22%. Chevron hasn’t risen as much as Devon because Chevron also owns midstream assets (pipelines), which provide reliable cash flows through the energy cycle, and downstream assets (chemicals and refining), which tend to underperform when oil prices are high, but benefit from low oil prices.
While Chevron can’t avoid the impact of energy price swings, the integrated model helps soften the peaks and valleys. Adding to the stability here is Chevron’s impressive balance sheet. It has a debt-to-equity ratio of around 0.25x, which is modest leverage for any business. When oil prices are weak, Chevron can take on debt to continue funding its business and dividend. When energy prices recover, as they always have historically, Chevron reduces leverage. The dividend has notably been increased annually for decades, which basically proves the company’s business model works.
Chevron won’t feel the pinch as much as Devon when oil prices fall, making it a better choice for more conservative investors. The dividend yield is 3.6% right now, which might also interest dividend seekers. That said, the best time to buy Chevron is usually when oil prices are weak.
Enterprise Products Partners(NYSE: EPD) and its midstream peers are likely to be the least impacted by rising and falling commodity prices. That’s because Enterprise owns energy transportation assets, such as pipelines, that help to move energy around the world. Midstream businesses generally charge fees for the use of their assets, meaning that the volume flowing through their systems is more important to their financial results than the price of the commodities they move.
This allows businesses like Enterprise to reward investors with large distributions through the entire energy cycle. The distribution has grown steadily over time, and Enterprise’s distribution yield is currently around 5.8%. When oil prices fall, the business isn’t likely to see a material impact. Even conservative investors will find Enterprise appealing today.
At the end of the day, you need to understand the fundamental business drivers of the energy businesses you own. In the upstream, oil prices are key. Integrated businesses aren’t as reliant on commodity prices, as they have other assets to mitigate price swings. And midstream businesses like Enterprise are simple toll takers with businesses that aren’t materially impacted by rising or falling commodity prices.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chevron. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.
Here’s What Falling Oil Prices Mean for These 3 Energy Stocks was originally published by The Motley Fool
