Oil Is a Value Trap: The Oil Price Looks Cheap but Isn’t

In today’s Money Morning…oil looks cheap but isn’t…governments are looking at renewable energy as a circuit breaker…other factors to consider when looking at oil price surges…and more…

Yesterday, my friend and colleague Ryan Dinse wrote to you about oil and changing energy markets.

I’m going to continue on that theme today and argue you need to be looking much further down the track as an investor.

As you can see, Brent [UKOIL] tacked on more than 40% from the low at the start of November to a high of over $50 just a few days ago:

This is the highest it’s gone since March.

Now cast your mind back to early November.

This is when the first murmurs of an effective vaccine started to gather force.

Today, the first group of Americans received the Pfizer/BioNTech vaccine.

And 40% is a fair climb given much of Europe is still in lockdown.

Here’s why you should be sceptical of the oil bulls out there though…

Three Ways to Invest in the Renewable Energy Boom. Click Here.

Oil looks cheap but isn’t

A value trap is another way of saying something is a ‘false bargain’.

It looks cheap but isn’t.

For instance, take this quote from one commentator via Oilprice.com (emphasis added):

‘Oil is increasingly being viewed as the cheapest of all reflation assets and with this in mind, the prospect for increased investor appetite, together with a recovery in demand, could propel prices higher in 2021.’

Beware when people say, ‘cheapest of all’.

It’s a bit like what’s happened with Whitehaven Coal Ltd [ASX:WHC].

For much of 2018 and 2019 it was trading at price-to-earnings ratio (P/E) of sub-10.

All while its share price slid aggressively.

If you were going off the crude value metrics alone, you might’ve been stocking up on WHC shares relentlessly hoping for an eventual coal renaissance.

Now headlines are emerging that China wants to hurt Australian coal producers.

This from the Australian Financial Review:

‘The Morrison government was urgently seeking answers from China on Monday night after reports Beijing had formally banned $14 billion of Australian coal exports in its latest trade strike…

‘The blacklisting of Australian coal is China’s latest move to punish Australia economically, following hits against wine, timber, seafood and barley. More than $20 billion of exports are suffering because of bans, punitive tariffs or “environmental” checks.’

So, like coal, oil is subject to the vagaries of a complex geopolitical landscape where alliances and rivalries shift.

Let’s not even get into the whole OPEC thing.

Which brings me to my next point.

Governments are looking at renewable energy as a circuit breaker

While many of their citizens are pushing for clean energy due to climate worries, I suspect many Western governments agree with them behind closed doors.

Not because of climate worries though.

No, they want to get one over their international rivals by cutting them off from their source of profits.

A circuit breaker of sorts.

What if OPEC didn’t run the show?

What if Russia’s Nord Stream 2 pipeline was meaningless?

What if China couldn’t punish Australia with import bans?

All of a sudden, you are left with a lot more bargaining power.

Other factors to consider when looking at oil price surges

There are a whole host of other reasons why oil isn’t cheap.

Take for instance these salient points made by one commentator on Bloomberg:

‘Recovery from the virus’s huge impact on economic activity won’t happen overnight. Take for example commercial flights, which are stuck at about 60% of last year’s levels after a rebound stalled in August. Hardest hit has been international travel, which accounts for almost all of the long-haul air traffic that’s the biggest consumer of fuel. How quickly those flights come back will depend on governments trusting each other’s vaccination regimes. If rollout is slow, or take-up is poor, vital air corridors may remain closed.’

And then there is the issue of stockpiles caused by the pandemic:

‘Even when demand from refineries does begin to rise, there are excess stockpiles of crude that also need to be drawn down. OECD crude stockpiles were up by 11% at the end of September, compared with a year earlier, and by 14% compared with 2018. In the U.S. inventories of crude and gasoline are both at their highest in at least a decade for the time of year.

‘On the supply side, the OPEC+ group of oil producers will add 500,000 barrels a day to oil supply next month. That’s less than initially planned, but could still be enough to tip an expected worldwide draw in oil inventories in the first half of 2021 into another build.’

Once you consider these points, the oil bulls have less of a leg to stand on.

Which means from a geopolitical perspective, a supply/demand perspective, and ultimately an investment perspective, you should be looking elsewhere.

You will hear more from us on energy in the coming months and I urge you to pay attention.

So, if you aren’t interested in oil, there are a range of options out there.

Particularly in the small-cap space on the ASX.

It’s well worth sticking around for.

Regards,

Lachlann Tierney,
For Money Morning

Lachlann is also the Editorial Analyst at Exponential Stock Investor, a stock tipping newsletter that hunts for promising small-cap stocks. For information on how to subscribe and see what Lachy’s telling subscribers right now, please click here.