On my premium subscription Tipping the Scale, everyone keeps asking me why I don't like energy stocks right now. While I don't argue that energy stocks could very well surge 20% in the blink of an eye, and that many stocks could double over a short course of time, I continuously look at the facts, and then I look away from energy stocks. In particular, there are two charts that really stick out to me and recent examples from the recession that everyone can relate to.
It is important to realize how oil prices stayed above $90 for most of the last decade, and that oil prices just recently collapsed without any warning whatsoever. Now, check out the following chart of two energy companies that first popped into my head, Exxon Mobil Corporation (NYSE:XOM) and Baker Hughes Incorporated (NYSE:BHI). These are two diversified, well established energy companies, but also very different types of companies.
XOM Capital Expenditures (Annual) data by YCharts
Oil prices are at decade lows, and at $30 per, there are not too many oil companies that can operate profitably in this environment. As seen in the chart above, the likes of BHI and XOM have made huge investments to grow, and were willing to increase their debt position because of high oil prices, and how much money COULD be made by drilling tons of oil in years prior.
In retrospect, oil was a gold mine, so companies spent ferociously to take advantage. But then the unexpected happens, supply increases, demand decreases and prices fall from a cliff. It reminds me a lot of 2008 when home prices started to decline and the rates on mortgages that were bundled and sold as securities skyrocketed - the teaser rates. The rest is history.
My point is that this dilemma with oil seems very similar. We have oil companies that spent aggressively to take advantage of high oil prices, much like banks who lent aggressively to take advantage of high demand for mortgages, and neither considered the consequences of what could happen in an oversupplied environment.
Now, I'm not suggesting that low oil prices will lead to the next recession. After all, low gas prices are great for consumer spending, whereas nothing good comes from a collapse in the credit and financial markets. However, there are trillions of junk bonds tied to this energy mess and reserves for storing oil that are essentially tapped out. While some stocks like Seadrill (NYSE:SDRL) and Linn Energy (NASDAQ:LINE) have fallen more than others, companies that cannot operate in a low oil price environment and have taken on way too much debt, others like XOM and BHI have not fallen in a way that I think appropriately reflects the problem at hand.
XOM has fallen just 17% over the last year, and BHI is down 31%. Given that oil prices have been cut from $105 to $30, I don't think energy companies, the big ones, have seen a rapid enough deceleration of value to make their stocks worth while. At best, these stocks are fairly valued according to the market, and at worst, they are still vastly overvalued. Either way, I think it is a huge risk to buy energy until oil prices recover, or stocks fall more, and I would certainly wait and see if there is more fallout to come.
Because remember, in July 2008 we knew there were issues in the housing market, and that prices were starting to fall. Still, no one knew the domino effect that would later come. The last thing you want to do is get caught up in a July of 2008-like situation, thinking the worst is over, and not realizing that $30 crude prices are just the tip of the iceberg.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.