Is it a good time to invest in oil companies? I think long-term investors should look elsewhere

Is now a good time to invest in big oil? It depends on your time horizon, but I believe future-focused investors should think twice.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

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 collapsed. So is now a good time to invest in oil giants? Their prices look right. Shares in BP are down by almost 40% from their year peak. Royal Dutch Shell shares are down by around a third.

Should the oil price recover, I would expect shares in BP and Royal Dutch Shell to recover too. But there’s a catch. I only expect this recovery to be short-lived and to be volatile long into the future. 

Oil price, what next?

Predicting what the oil price will do in the short run is a mug’s game. But I do think that in the medium term, let’s say over the next half a decade, the price will go up. Yet longer term, I have my doubts.

The oil cycle moves slowly. When the oil price is high, we gradually change habits. As our car ages, we may replace it with a more fuel-efficient model. Simultaneously, we may insulate our loft or buy solar panels. Industry will change habits too, but slowly. As for oil supply, under these conditions, the oil industry typically invests more in exploration.

Human nature being what it is, a narrative then emerges that the elevated levels of that period will become permanent. However, as a consequence of the slow changes I described above, eventually oil supply rises just as oil demand falls. The price then crashes.

When oil is cheap, we see the reverse conditions occurring, gradual changes in demand and supply happen, until the oil price increases.

These slow-moving changes in demand and supply is why we have an oil market cycle.

Post-Covid

Once the Covid-19 crisis finally ends, there will still be a massive oil inventory. I expect the economy to recover slowly, but eventually, demand for oil will rise and the oil inventory will disappear.

For that reason I expect the oil price to surge again later this decade. In theory, shares in oil companies will recover at that point, perhaps a little before.

The end of the cycle

I also suspect that cheap oil will slow the advance of renewable energies and electric vehicles. But I don’t expect this to be significant. The economics of electric vehicles are becoming ever more compelling, not least because they have fewer moving parts and can be cheaper to maintain. The cost per unit of energy of renewables is constantly falling, as is energy storage costs.

And let’s not forget the one extremely important factor missing from the above narrative — climate change.

Just as the world has reacted to the threat posed by Covid-19 with a lockdown, irrespective of the economic costs, I suspect that in the second half of this decade, when the reality of the true costs of climate change finally sink in, we will rapidly move away from oil, and adopt alternatives regardless of the costs.

Fortunately, by then I expect the cost of energy generated by renewables to be so cheap that the economic damage caused by a switch away from oil will be modest.

Oil companies will be hit hard by this move away from their core product. I still think the oil giants looks interesting as they’re investing in oil alternatives. But I’d need to see more proof of how these investments will boost their businesses before I buy.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Michael Baxter has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

Here’s how a Stocks and Shares ISA and Lifetime ISA could supercharge my wealth!

Individual Savings Accounts (ISAs) can help UK share investors take their earnings to the next level. And their importance is…

Read more »

A person holding onto a fan of twenty pound notes
Investing Articles

A high-yield dividend ETF and an investment trust to consider this November!

Investors wanting to boost their passive income could benefit from investigating these high-yield funds and trusts, says Royston Wild.

Read more »

Investing Articles

2 of my favourite, cheap FTSE 100 growth shares this November!

These FTSE 100 growth shares could be great long-term picks to consider, reckons Royston Wild. At current prices he thinks…

Read more »

Investing Articles

Up 26%, can the BT share price really push higher still?

The BT share price has surged on several catalysts in 2024, but there’s evidence to suggest that the stock could…

Read more »

Man writing 'now' having crossed out 'later', 'tomorrow' and 'next week'
Investing Articles

What are the best dividend shares to buy right now?

As shares in B&M European Value Retail have fallen, the dividend yield has reached a 10-year high. Should investors be…

Read more »

Surprised Black girl holding teddy bear toy on Christmas
Investing Articles

My favourite FTSE 100 passive income stock that keeps the Christmas coffers full

The holiday season is expensive and can leave many consumers struggling to make ends meet. Here’s how I use a…

Read more »

Investing Articles

The latest growth forecasts suggest the Glencore share price will hit 555p!

Harvey Jones has been disappointed by the performance of the Glencore share price since he bought the commodity stock last…

Read more »

Dividend Shares

A closer look at the 11% dividend yield forecast for Phoenix Group shares

Phoenix Group shares have one of the highest dividend yields in the FTSE 100 index today. Could this be a…

Read more »