A great opportunity is emerging in the energy sector. Declining oil prices have created a 2008 recession- like decline in the shares of energy stocks across the board. Indeed, many share prices today are trading lower than they did when the Great Recession of 2008 was at its depths.
The reality is that a recession is not all that important to the valuation of energy stocks; the price of oil is what matters. Oil is arguably the world's most important resource today and its use is required to keep society functioning. Even during weak economic times, oil is still required and thus oil companies make it very well. But today, even while the economy seems to be doing well, oil at $50 a barrel has made energy stocks the worst-performing investment sector.
Keep in mind, though, that the price of oil goes through cyclical structures, and today the price is near the bottom of a cycle. And so, a quality operator such as Murphy Oil (MUR) finds itself trading at 84% of book value, even though Murphy has a very quality balance sheet, with $2.6 billion in debt supported by $1.4 million in cash and more than $8 billion in equity.
Until the price of oil begins to move back up, energy shares will remain depressed even for first-class players such as Murphy. However, the cycle will eventually turn. Many of the operators today in the U.S. are overleveraged, yet they still pump oil thanks to easier debt covenants and the ability to extract more oil via fracking. The problem is that the extra oil is being used to service debt and not generate profits.
Eventually, Charles Darwin takes over, and the weaker players slowly will fold. Supply will recalibrate and the cycle will turn. And names such as Murphy, Consol Energy (CNX), and Canada's Bellatrix (BXE) will be big winners in my view. Natural gas giant Chesapeake Energy (CHK), which I've written about before, also will be a huge winner.
But getting there will not be for the timid investor.