Why I avoid oil shares like Woodside Petroleum Limited

Does the rise in oil price make oil shares like Woodside Petroleum Limited (ASX:WPL) a buy?

| More on:
The shadows of an oil rig and two businessmen shaking hands with a sunset backdrop

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The oil price has been on a tear lately with WTI crude up around 34% to US$65.70 per barrel in the past year.

This is good news for oil and gas stocks such as Woodside Petroleum Limited (ASX: WPL), Oil Search Limited (ASX: OSH) and Beach Energy Ltd (ASX: BPT) but perhaps not as good as you might think.

Both Woodside and Oil Search have ownership stakes in LNG projects and so a large chunk of their reserves are made up of gas rather than oil.

Similarly, only around a third of Beach Energy’s reserves are in the form of oil. Whilst oil and gas prices are linked, the correlation isn’t that strong and so higher oil prices don’t necessarily translate to an equivalent uplift in asset value for the three producers above.

Oil prices are volatile and hard to predict but broadly speaking they tend to increase in times of global economic prosperity. This is caused by increased industrial and consumer demand combined with static supply due to the time it takes to bring new projects onstream.

Also, like other commodities, oil retains its purchasing power when inflation spikes which is often a by product of strong economic growth.

These conditions exist today but are unlikely to persist. Rising inflation prompts interest rate hikes which eventually cause the economy to turn down taking inflation with it. So whilst the short-term outlook for oil companies is good, they remain highly cyclical and so the best time to buy them is when their share prices are suppressed.

I also believe that fossil fuels are in very long-term decline defined as the next 50 to 100 years.

The gigantic and mounting climate change threat means that this fate is inevitable to avoid widespread disaster and renewable energy technologies are already gaining market share. Such technologies will only improve over the coming decades and so the pace their adoption is set to accelerate.

Then there is the economics of the business of oil production. By definition commodity companies have no pricing power which translates to low shareholder returns through the cycle. Also, because reserves are continually diminishing funds must be constantly funnelled into exploration which is a unpredictable and therefore a particularly risky form of investment.

I tend to avoid the resource sector for these reasons and as far as I can tell the only saving grace of such shares over the long-term is their ability to hedge inflation. Even then, I think that holding some gold or inflation linked bonds is a better alternative since these also perform when the economy and stocks suffer.

Motley Fool contributor Matthew Brazier has no position in any of the stocks mentioned. You can find Matt on Twitter @MattBrazier2 The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on ⏸️ Investing

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

asx share price competitions represented by businessmen arm wrestling
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »

person reading news on mobile phone
⏸️ Investing

Why Fox (NASDAQ:FOX) might hurt News Corp (ASX:NWS) shareholders

News Corporation (ASX: NWS) might be facing some existential threats from its American cousins over the riots on 6 January

Read more »