Is Now the Time to Invest in Oil Stocks?

July 30, 2010, 8:24 pm

In 2007, Oil become of the most speculative investments before the market crash wiped out a lot of the money that helped pushed this commodity to nearly $150 per barell. Fast forward three years later and the BP fiasco in the Gulf of Mexico leaves one wondering whether oil companies, and BP in particular, will have a tough time earning a profit when the government will have to be a lot more strict about offshore drilling (and likely drilling altogether). Should investors avoid holding oil companies in their portfolios with this in mind or should they jump at the opportunity to own them while they are “bruised?”

Some large, institutional investors feel one way while others feel the other.

Reasons to Buy

In addition to the oil companies lacking common appeal, there has been a lot of selling pressure which has not only impacted BP’s price (although this one has been the hardest hit) but others in the segment. This “fear” evidently presents tremendous opportunities — Warren Buffett was the one who said “buy when others are fearful and sell when others are greedy.” The market sentiment at this moment is definitely one of fear.

As well, even more strict rules surrounding offshore drilling in the US, the prospects of alternative energy sources and a host of other what-if’s, the fact remains that there will almost always be a huge demand for the service these companies provide. As the technology becomes more and more perfect, profitability will return even after such huge losses.

As an added bonus, even BP pays a dividend. When prices are depressed as they are, that dividend yield looks extremely attractive (although there could be some risk of the dividend disappearing after such monumental losses). This ultimately is yet another reason to buy.

Reasons to Avoid

Avoiding these types of securities is not out of the question. Some of the largest investment funds have dumped these types of securities en masse after the problems in the Gulf, feeling that such disasters are not isolated to BP alone and that it is just a matter of time before worse problems show up. This will result in even steeper losses for whichever company is unfortunate enough to encounter such problems in the future.

As noted above, the dividend that many of these companies could be pulled due to the risk of future losses (or current losses as in the case of BP). Without the dividend, some may not find these securities all that attractive at all. Combine that with the prospect of huge government sanctions that could be imposed on all oil firms and it could appear that investing elsewhere is the more-preferred alternative.

Lastly, this industry is a rather mature one. Many investors seeking better growth opportunities might prefer leading-technology firms that are seeking oil-alternatives. Investing in such companies early enough often yields tremendous gains, even though they are highly speculative in their infancy.

What To Do

Incorporating an oil component to your portfolio is really a matter of choice. Depending on your views as to the future of the industry, you may want to invest heavily, a little, or not at all. However, investing in companies with great future prospects, a good dividend and strong balance sheet should always be an investment priority, regardless of the industry.

–> Dividend Funds Reviewed at the Mutual Fund Site.

Chris has more than 17 years of financial services experience. He currently manages a website about Getting Rid of Ants at GettingRidofAnts.org.

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