To The Moon

Perhaps the daily updates we always wait for in the morning and evening news is the price of oil given the hostilities between Russia and Ukraine.

But maybe you’re also wondering why this conflict is such a huge factor in the global oil price changes.

And for investors, Warren Buffett’s increasing stake in oil companies can be quite puzzling.

Let’s start explaining these things by this fact: Energy stocks are outperforming the stock market amidst the global inflation issues.

But before you jump to another page looking for the best energy stocks to invest in this year, get yourself equipped with knowledge on how energy stocks and investing in them work.

The energy sector

Why are we always looking at oil prices? It’s simple. The energy sector produces and supplies the electricity we need to power our supply chains. In other words, it’s crucial in making the economy run.

You can observe this recently. With the Russia-Ukraine conflict, oil supplies are cut off. Hence, demand is up while supply is down. Prices of goods, therefore, increase, as the supply chain needs energy products to function efficiently.

This is not all there is though. The energy sector is broad. It’s not just all about oil. It also covers all activities related to oil, gas, and even renewable resources.

Just as marketing has its upstream and downstream, the energy sector has, too. Upstream companies are those that are involved in the exploration of energy sources. Downstream, on the other hand, are those focusing on the refining and processing of these products.

There are also renewable energy stocks. Today, when the world is becoming increasingly aware of the negative impacts of carbon and fossil fuels, renewable energy sources are becoming more popular.

You can see this in the uptake of solar power and the return of discussions about geothermal and even nuclear power. So renewable energy stocks are those that provide green energy sources. The most popular ones are solar energy stocks and wind energy stocks.

Of course, there are oil and natural gas stocks. These companies find produce, refine, store, and even transport fossil fuels and natural gas (liquefied). Examples are the biggest energy stocks, $Chevron(CVX)$ and $Exxon Mobil(XOM)$.

You can also opt to consider pipeline and refining stocks. These, meanwhile, are companies that take the raw materials, for example, crude oil, and process them for consumers’ use.

Another feasible option is looking at utility stocks. They generate and distribute electricity to consumers.

Investing in energy stocks

Energy stocks, specifically oil stocks, have been popular with investors because of Buffett’s bullish attitude toward the sector.

Just this year, Buffett’s company, Berkshire Hathaway, has increased its stake in Chevron, one of the top oil stocks. He bought it in 2020, along with other energy stocks. Last month, Buffett’s Berkshire Hathaway also won approval to buy as much as 50% of the shares of $Occidental(OXY)$.

Likewise, every investor would see how the energy sector in the S&P500 has been raking the highest profits amidst the general stock market slump.

Plus, investors are attracted to the dividends. Most often than not, energy stocks pay dividends to their shareholders, some even ranging from 3.5 to 5%.

What draws investors in

So why are energy stocks good investments?

Of course, there are dividends that they generously share. This gets particularly attractive at times like today when energy prices are high. So when the companies generate more profits, it also means higher dividends (yes, passive income!) for investors.

Or even if the company decides to not give it out yet, investors can be confident that the money will be used for the company’s further growth… and in the long run, still benefit investors.

Second, the energy sector is huge and is essential to keep the economy humming. This sector accounts for trillions of dollars annually, and we cannot survive at all without power, whether it comes from fossil fuels or green energy sources. Suffice it to say that 10 years from now, the energy sector will remain an important sector of the global economy.

Next, the demand for energy goes up as the population also grows and countries develop. We’ve observed this in emerging economies like China, which, as its economy grows, requires more energy supply to power its manufacturing and other industries.

But there are also drawbacks.

What are the risks

Energy prices are highly volatile. They can change in the blink of an eye. Geopolitical shifts can send oil prices and energy stocks’ prices ceiling high or extremely low.

Just look at what happened when the Russia-Ukraine conflict started. And until today, we are not sure what the ceiling price would be. Energy prices can suddenly go up and then drop as well.

For example, during the pandemic’s early days, demand was low because of movement restrictions and postponement of some business operations, hence the price plunged. Then we saw it going up again when borders reopened and travel resumed. Today when there’s ‘revenge travel’ becoming popular, energy prices will most probably shoot up.

You should also be aware of the issues surrounding the sector, especially oil and gas companies which comprise the majority of energy stocks. As countries are gearing towards sustainability, lawsuits may ensue and impact the company you wish to invest in. With this, it’s better to diversify between green energy stocks and traditional ones, i.e., fossil fuels.

How to choose the best

With the sector’s volatility, it is often best to choose energy stocks which have consistent stable performance at a time when the commodities market, in general, is at its lowest.

Likewise, you must include a low-risk business model in your criteria. An oil company with diversified operations and one that has minimal production costs would be a good investment.

Of course, stable revenues are non-negotiables given the volatility of the sector. It has to have high liquidity.

With regard to dividends, it’s recommended to settle for energy stocks with conservative payout ratios as you also would want to look at the share price movement.

Don’t just invest in an energy stock because it’s doing well now. Check if its financial figures are up solely because of the ongoing conflict. Ask yourself: What then when the war ends? Will the stock still perform?

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Disclaimer: All facts and opinions presented are for educational purposes only. This is not a recommendation to buy or to sell. Please do your own due diligence.