COVID-19 and the Ukraine war are driving up oil prices. Here are five energy stocks with strong performances to add to your investor watchlist.
For those familiar with investing, you’ve probably heard the theory that energy stocks tend to be inversely correlated with the stock market.
Now, it’s important to note that rising oil prices don’t directly cause recession, just that there is a pattern that has proven to be pretty reliable thus far.
But then again, there’s no denying that high oil prices contribute to inflation, as oil and its by-products are used in virtually everything and everywhere today.
That’s a debate better left for another day; the main thing to understand here is that since energy stocks tend to move in opposite directions to the rest of the stock market, they can help to shore up your portfolio when everything else is falling off a cliff.
This, then, illustrates the main reason to buy energy stocks — they can act as a hedge against market downturns, exerting a moderating force and preventing your portfolio from losing too much of its value.
Understanding energy stocks
Before we go further, it’s important to clarify that energy stocks don’t all behave the same way as described above. This is because there are several different types of energy stocks, which may be complementary or contrasting to each other.
Loosely speaking, there are four main categories of energy stocks. However, know that it is common for some companies to operate across more than one category.
- Oil and natural gas stocks. Companies involved in searching for new sources of fossil fuels, extracting and processing oil and natural gas, and supplying them to the market. The value of these companies is derived from their existing sales as well as the worth of untapped oil and gas reserves that have been claimed for future extraction.
- Pipeline and refining stocks. Oil refining companies refine the extracted crude oil and natural gas into fuel that is ready for industrial or commercial consumption. They may also process and sell by-products that come from the refining process. Meanwhile, pipeline companies are mainly involved in the transportation of processed oil and gas.
- Mining stocks. These companies are in the business of mining resources from the earth that are important in meeting the world’s energy needs. One such resource is coal, which remains a key resource in parts of the world, such as China and India. Another is uranium, which is used as fuel in nuclear power plants.
- Renewable energy stocks. Companies that focus on green sources of energy, such as solar power, geothermal, wind, hydroelectric, etc. Note that renewable energy stocks can have a different trajectory than fossil fuel energy stocks, due to their very different processes and business life cycles.
Pros and cons of investing in energy stocks
|Energy is (and will continue to be) one of the largest and most important markets in the world||Increasingly urgent environmental concerns and heightened scrutiny, which could lead to tiger regulations|
|Good potential for high returns over the long term||Highly volatile, prices can experience large swings over short periods|
|Energy stocks offer a degree of diversification owing to the complexity of the sector||Companies need to make large and costly investments, which could impact profitability and/or dividends in the short term|
|Global demand is expected to continue growing, even if fossil fuels start to be phased out||Certain types of energy stocks may face dwindling demand as climate change progresses|
Five best energy stocks for 2022
|Exxon Mobil Corp (XOM)||+51.24%|
|Phillips 66 (PSX)||+37.48%|
|EOG Resources Inc (EOG)||+43.99%|
|Marathon Petroleum Corp (MPC)||+56.37%|
|Brookfield Renewable Corp (BEPC)||-5.4%|
Source: Google Finance
Exxon Mobil Corp (XOM)
Exxon Mobil once held the lofty title of being the largest energy company in the United States. Judging by recent moves the company made, it looks poised to make a return to form.
One highlight is its Q3 2021 performance, which saw a profit of nearly US$6.8 billion, in sharp contrast to a US$680 million loss the year prior. The company also achieved operational cash flows of US$12 billion, which enabled it to cover the costs of capital investments and shareholder dividends, while paying down a portion of its debt.
On the back of such strong results, Exxon Mobil has pledged to resume its stock buyback programme this year, which only creates more upside for investors.
Phillips 66 (PSX)
One of the largest independent oil refineries in the States, Phillips 66 last year achieved earnings of US$1.9 billion in the first three quarters of 2021. That’s almost double what the company earned for the whole of 2020.
The surge is attributed to a recovery in demand for plastics, which Phillips 66 is well-poised to capitalise on as a major producer of high-density polyethylene (HDPE) plastic, polypropylene plastic and various other chemicals in its joint venture with Chevron.
For Phillips 66, this decision to diversify from focusing solely on petroleum refining for automobiles proved to be the right one.
But by no means are its refining and midstream businesses lagging behind; the company saw increased revenue from those divisions in 2021 as well.
EOG Resources Inc (EOG)
Perhaps no other energy stock exemplifies the power of being a first mover better than EOG Resources.
The company was one of the first to move in on the more productive shale fields in the US — this was before fracking took off — and as such, managed to claim a large acreage of shale fields at rock-bottom prices. This has rewarded the company with a low cost of oil production throughout its history.
How low? Well, EOG Resources’s break-even point for the crude oil it produces is a mere US$40 per barrel. For context, oil prices in the past 12 months have ranged from US$75 to over US$120 per barrel.
This healthy margin has helped propel the company to new heights. In 2021, EOG Resources attained new record highs in free cash flows of over US$1.1 billion twice — once in Q1 and again in Q3.
This massive profitability has trickled down to investors, who last year benefited when dividends were increased twice, with a separate dividend payout capping off a lucrative year.
Marathon Petroleum Corp (MPC)
Marathon Petroleum is the largest independent refiner of crude oil, with 16 refinery plants across the US.
Since being spun off from oil exploration and production company Marathon Oil in 2021, MPC has continued to enjoy a steady flow of earnings, earnings which are now rising on the back of increased demand for petroleum.
Additionally, Marathon Petroleum Corp continues to receive a healthy flow of dividends from its natural gas holdings (via its master limited partnership MPLX).
It is also seeing benefits from its cost-lowering programmes, through which the company managed to drive down the cost of production by about a dollar per barrel.
Additionally, the company has acquired a strong cash position worth about US$10 billion after successfully selling off a convenience store chain, and is expected to use part of this proceeds to buy back shares, reduce debt, and increase dividends.
Brookfield Renewable Corp (BEPC)
Our fifth and final recommendation is a renewable energy stock.
Brookfield Renewable is among the largest renewable energy producers in the world. Its hydroelectric power division makes up around 60% of its portfolio, with wind, solar and energy storage making up the rest of its business.
While its stock price is slightly down year-to-date, don’t let that detract from the company’s excellent track record. Since inception, Brookfield Renewable has attained an annualised total return of 20%, powered by a steady expansion of its portfolio through acquisitions and development.
This strategy has enabled the company to achieve a compound annual growth rate of over 10% in the past decade, as well as 6% compound annual growth in dividends payments since 2012.
With the ongoing shift into renewable energy, Brookfield Renewable has a bright future ahead. The company is expected to achieve up to 20% growth annually through 2025, which will allow it to increase dividend payouts by 5% to 9% each year.
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