As an industry linked to commodities, the Oil & Gas sector often experiences huge market fluctuations. In the second half of 2023, with the production cuts by Saudi Arabia and Russia, the stock prices of oil companies 'took off' again, bringing the attention of many investors back to this sector.

Some investors may have a question—Is investing in energy companies a wise choice? This opportunity exploration will take you deep into the potential investment opportunities and risks in the Oil & Gas industry.

What factors influence oil prices?

Oil can provide fuel for transportation and power. According to research, there is a significant positive correlation between the global GDP growth rate and global oil consumption. Therefore, oil is crucial to the global economy; changes in oil prices not only affect investors but also constantly impact the general public worldwide.

However, the oil market is a seller's market, and prices are primarily influenced by oil-exporting countries like Saudi Arabia and Russia (OPEC+). Against this backdrop, competition within the oil industry is fierce and unstable, as OPEC+ actions may conflict with the interests of publicly listed oil companies. If OPEC announces significant production cuts, the oil market may face a supply-demand imbalance, leading to a sharp rise in oil prices, and stock prices of oil companies may also soar. Are these influences consistent throughout the oil industry? The answer is, not necessarily! Below, we will briefly introduce the oil supply chain.

Classification of the Oil & Gas industry

Upstream: Exploration, drilling, and extraction of oil. This is the part of the industry chain most easily affected by oil price fluctuations. The largest exploration and production company in the United States is ConocoPhillips (NYSE: COP), and Occidental Petroleum (NYSE: OXY), which Warren Buffett buys on dips, is also in the upstream of the supply chain.

Midstream: Transportation, processing, and storage of crude oil and other refined oil products. Midstream companies typically conduct business using fixed rates and long-term contracts; thus, their profitability is less affected by oil price fluctuations. Enterprise Products Partners (NYSE: EPD) is a major midstream company.

Downstream: refining crude oil into fuels or selling refined products to consumers. For example, gas stations and refineries are two types of downstream companies. Downstream companies profit from the difference between oil prices and refined product prices, and when oil prices fall, the decrease in demand for refined products often impacts the downstream sector. Phillips 66 (NYSE: PSX) is a major downstream company.

It is worth mentioning that there is a comprehensive sector within the Oil & Gas Industry, with listed companies operating at multiple stages of the Oil Supply Chain. Well-known companies such as Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX) are two examples of "integrated oil giants."

Can oil stocks benefit from rising oil prices in the long term?

Firstly, whether oil stocks can rise depends on a key factor — oil prices. "Betting that oil prices will continue to rise" is the core logic behind many investors, including Warren Buffett, investing in oil stocks.

In terms of news, in September 2023, the International Energy Agency stated that Saudi Arabia and Russia have extended their oil production cuts until the end of 2023. The market believes that this move may lead to supply shortages for the remainder of 2023, which has caused U.S. crude oil prices to break through $90 per barrel for the first time since November 2022.

As more and more Analysts believe that "crude oil prices may break through $100 per barrel," is now the best time to enter the market?

However, fundamental factors are also very important. Taking two comprehensive oil leaders, Chevron and Exxon Mobil, whose businesses run through the entire Oil & Gas industry chain, as examples, we analyze the potential upside of the entire Oil & Gas stocks.

According to Zacks' analysis, Exxon Mobil's EPS is expected to decline by 36% in 2023; in terms of valuation, the expected PE ratio is 13 times, while the average for the Oil & Gas sector is 9.3 times, which is significantly higher than the industry average but still far behind the S&P 500's 20.8 times.

Chevron's EPS for the fiscal year 2023 is expected to decline by 30%; the expected PE ratio is 12.5 times, which does not represent a high premium compared to the industry average of 9.3 times, and it is far lower than the S&P 500's 20.8 times.

The PE ratios of these two stocks are still within a fairly reasonable range, and looking at this alone, buying stocks of these oil giants seems quite attractive. However, in terms of future profitability, the EPS of both companies is disappointing.

Both companies have made a strong rebound from the pandemic. Over the past three years, Exxon Mobil's stock price has surged by 223%, while Chevron's stock price has increased by 119%. However, the current global economic landscape is more complex, and it may be difficult to replicate past outstanding performance: as of September 21, 2023, Exxon Mobil's stock price has slightly risen by 6.6% year-to-date, while Chevron has decreased by 5.3%. Chevron and Exxon Mobil are expected to release their third-quarter reports at the end of October. Currently, both companies’ revenues and profits are expected to decline significantly. Analyst Zucks believes that under increasingly challenging competition, whether stock prices can further rise will depend more on company performance, such as revenue and profit.

Potential Risks and Opportunities.

According to The Motley Fool, here are several significant risks you must know when investing in the Oil & Gas Industry:

1. High Volatility.

OPEC countries control oil pricing, which is beyond the control of oil companies. Additionally, the Industry Chain of oil is also affected by factors such as extreme weather and geopolitics. "Black Swan events" have magnified the volatility and uncertainty within the Industry. With the fluctuations in oil prices, stocks in the oil market also tend to display high volatility.

1. Cyclicality.

As mentioned earlier, the Oil & Gas Industry is closely linked to the global economy, and therefore, the Industry often follows changes in economic cycles. If signals of a global economic recession appear, the demand for oil will also decrease with consumer spending, and oil prices will likely fall as well. Investing in oil at this time is certainly not a wise choice. Thus, recognizing economic cycles is key to entering the Oil & Gas Industry.

1. ESG.

The awareness of using clean energy is increasing year by year, and the environmental requirements are becoming stricter. Therefore, establishing a carbon emission management strategy is key to the sustainable development of the future NENGYUANHANGYE. On the path of energy transition, the oil industry may also face potential obstacles. For example, the Wall Street Journal reported that in recent years, Exxon Mobil executives have questioned the dangers of climate change and the necessity of reducing oil usage, leading to Exxon Mobil being sued alongside several other Oil & Gas companies.

Similarly, analysts from The Motley Fool believe that selecting promising oil companies can reference the following two points:

1. Industry Leaders

Like many other industries, larger companies often carry less risk. This is because leading companies are likely to have strong balance sheets, which not only puts them in a favorable position within the industry but also protects them during oil price crashes due to their good financial health. In other words, even in the face of 'black swan' events, large companies have a lower probability of bankruptcy in the short term.

1. High Dividends

Some investors are often attracted to the high dividends of listed companies in the oil industry. Indeed, this is because, during high oil prices, the related listed companies often generate substantial cash. This money may be used to drill more wells, pay off debts, buy back stocks, and pay dividends, during which time the dividend payments of listed companies exceed normal levels. Similarly, for investors, the rising prices of oil stocks and attractive dividend income can yield considerable returns.