CEOs of Chevron(NYSE:CVX) again ExxonMobil(NYSE:XOM) both cautioned that oil prices do not fully reflect the current state of the oil market. The latest update on that comes from the United States, where US oil reserves are dangerously low, with a warning from a refiner. Phillips 66(NYSE:PSX) about the issue. What is happening and what should investors do now?
Oil is a global commodity
Oil is global, so events in the Middle East affect the entire world. Oil exports from the US market increased as flows from the Middle East slowed, with oil users looking for supplies wherever they could be found. Oil production in the US was not directly affected by the war, and the country is one of the largest oil producers in the world, so it was a logical place to look. Companies like Devon Energy(NYSE:DVN) again Diamondback Power(NASDAQ:FANG) they are likely to be net beneficiaries of higher oil prices and increased US oil demand.
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However, the real danger of the reduction in US stocks is that it can only last so long before the high level of exports needs to be reduced. At the end of May, inventory at Cushing, a key US energy hub, stood at 22.4 million barrels, down 4 million barrels from February. Industry watchers warn that hitting 20 million barrels could cause operational challenges for energy companies.
So US oil is only a temporary solution to the much bigger problem caused by the conflict in the Middle East. There just isn’t enough oil to go around right now, which is what Chevron and Exxon are saying. Oil is a commodity, so prices rise when supply is tight and demand is high.
Sentiment drives the oil market
The problem is that Wall Street is often driven by emotions in the short term. Chevron and Exxon are looking at the big picture, with time frames that look out ten years or more. Investors, because of the dramatic, rapid swings in oil prices, are watching news from the Middle East conflict and reacting quickly.
Energy industry executives are very clear that there is no quick fix to the current oil shortage. It may take months to resolve the crisis in the Middle East, and the healing process will not begin until the conflict ends. There is no end in sight at this time.
Investors should tread carefully. It is tempting to take an aggressive position, betting that oil prices will rise materially. That’s what Chevron and Exxon are warning about, after all. Pure-play drillers like Devon and Diamondback would be a solid choice in such a situation.
However, given the disconnect between prices and industry fundamentals, it is also clear that sentiment is currently more important than industry fundamentals in the oil market. Given that, it probably makes sense to hedge your bets a bit. For many investors, the best option may be integrated industry giants like Chevron and Exxon. They have diversified global portfolios, exposure to the entire energy value chain, and outstanding balance sheets. They are built from the ground up to survive the entire energy cycle, as each has been proven to grow its share annually for decades.
Chevron and Exxon are ready for the worst
Neither Chevron nor Exxon are likely to be the biggest beneficiaries of higher oil prices, but they will benefit materially nonetheless. So buying either one will give you good exposure to the oil price that both companies warn about. However, they are also well positioned to weather low oil prices, giving investors a valuable backstop if emotionally driven oil prices move in unexpected directions.
Given the importance of oil to the global economy, most investors should be able to gain exposure to the energy sector. Companies like Chevron and Exxon are solid, long-term options for that exposure.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chevron. The Motley Fool recommends Phillips 66. The Motley Fool has a policy of disclosure.
US Crude Oil Storage Levels Are Declining Toward This Critical Level. Here’s What Investors Need to Know was originally published by The Motley Fool
