After all the fun yesterday, the talk last night turned to more serious matters like the pitching woes of the Baltimore Orioles, the Cubs' chances of making the playoffs and when to up the commitment to energy stocks.
I started buying energy stocks last year, added in December and then cut some of the more financially challenged ones around February. Even adopting a more cautious approach has not helped, however, as the oil portion of my portfolio has been beaten like the Orioles against the Twins this past weekend.
Fundamentals have declined along with the price of oil and it is hard to find energy bargains that look safe enough to qualify for potential new buys. Thankfully, the energy portion of the portfolio is fairly small.
What to do about energy stocks rests on how long your timeframe is and how much pain you can take. I am in full agreement with David Rubenstein of The Carlyle Group (CG) that energy is probably the best investment in the world. Keep in mind, though, that Rubenstein is looking out many years.
If you are trying to speculate on short-term price direction you are likely to get whipped around like a kitten chasing a laser light wielded by a bored five-year-old. I have seen dozens of oil bottom calls in the past few months. They have all been delivered confidently and are backed by solid data and research. They have all been dead wrong.
Even though oil prices have fallen more than 60% in the past year and are below $40 per barrel, an awful lot of that oil is still being pumped at a profit. Some of the fields in Saudi Arabia, Kuwait and Qatar are operating at below $20 a barrel. Although their economies are planned around much higher prices they are not losing money on the oil being pumped.
In parts of the Bakken, the breakeven cost is below $30, and on older shale rigs around the country the sunk costs have already been expensed and the wells are profitable in the high teens. Oil can, in fact, go lower without killing many of the producers.
It is only when the higher-cost producers have been pushed out that there will be production declines around the world .Then we will see supply and demand level out and prices firm and rise a bit. I have no idea when that will happen and no one else does either, in my view. Geopolitical risk is always hanging over the oil fields so there are just too many wildcards to make a sensible prediction about the near-term direction of oil prices. However, while I don't when this will happen, I am reasonably confident that it will.
Longer term, I believe the picture is a little clearer. At some point the supply and demand imbalance will correct as higher-cost producers leave the business and the global economy improves. With that viewpoint, many oil and gas-related companies are cheap. Chevron (CVX) is actually trading below book value and I do not see any other instance of the stock being that cheap in the last 15 years. Energy stocks are down 50% or more over the past year. Those that can survive until prices firm and then can thrive should provide enormous gains.
I did buy some energy shares yesterday, but I took a cautious approach. I purchased Adams Natural Resources Fund (PEO) to give me a diversified portfolio of energy stocks and, best of all, the closed-end fund trades at a 15% discount to net asset value so I got a bargain price on bargain stocks. PEO's top-10 holdings are Exxon Mobil (XOM), Chevron (CVX), Schlumberger (SLB), Phillips 66 (PSX), Occidental Petroleum (OXY), EOG Resources (EOG), LyondellBasell Industries (LYB), Dow Chemical (DOW), CF Industries (CF) and Anadarko Petroleum (APC) and comprise 60% of the portfolio. Exxon and Chevron, alone, make up 25% of the fund's portfolio, so we are basically buying blue chips at a nice discount.
PEO started trading back in 1929 so these folks are familiar with oil prices and should be able to navigate the current difficult market. The fund has committed to paying an annual distribution of at least 6% of PEO's average price so you collect a nice yield while you wait for energy prices to improve.
I like PEO, but keep in mind I have the time for it to work out and am willing to take a fair amount of price pain while I am waiting. I am looking out seven to 10 years and am perfectly willing to buy more if energy prices go lower before firming.
If you believe, as I do, that energy stocks will be fine in the very long term this is an excellent selection.