Revisiting KCR’s Long-Running Thesis on the Opportunity in Oil Angst
Starting in May of 2020, KCR’s research team wrote nearly a dozen pieces making the case for oil. On September 8th, we published Oil Company Stocks to Buy, which summarized our work up to that point and pounded the table for investing in oil stocks. With oil trading below $70, we led out by explaining that oil and natural gas commodity prices did not need to rise to turn oil and gas stocks into powerhouses for investors.
Immediately after, we published our review of the IEA’s Net Zero Emissions report. In that piece, we explained how ESG advocates and policymakers had woefully misrepresented the researchers’ work. In our view, the report was a dire warning that barring changes nowhere in sight, that oil was heading higher. After highlighting Devon Energy as our top energy stock in the oil and gas industry in September, we took on the speculative receptacles of capital and highlighted a group of renewable energy stocks as shorts in November.
Prior to the geopolitical tragedy underway, oil and gas prices ran 50% and took Devon and the stocks we’ve highlighted along the way ripping higher. Meanwhile, the clean-tech stocks we panned have imploded. KCR highlights the above not because we got something right. Instead, it is because in every piece we highlighted, ad nauseum, that we were not energy experts. Our thesis was painfully simple and worked beautifully before the horrifying situation in Ukraine.
We grew up learning from Dennis Gartman that the “cure for high prices is high prices.” We have no doubt that will be true again. Yet this paper explains why we believe energy stocks may run a great deal farther, and highlights some of our favorite oil stocks to buy.
Figure 1 below updates the lead in chart to our piece Are Crude Oil Prices Reflected in Energy Stocks?, which also featured a collection of magazine covers highlighting the madness of crowds. KCR believes the chart below could almost be a stand-alone thesis for why energy stocks may have farther to run.
Valuing Energy Companies is Not Usually This Easy
KCR would like to reiterate that we are not energy experts. We say that a lot. But we do have a deep appreciation for the value of free cash flow as a powerful driver of returns.
Figure 2 below is a testament to just how unloved energy stocks are today. Inventories of distillates and crude oil were well below long-run trends prior to the Russian attack on Ukraine. Since the Russian invasion on February 20th and the West’s subsequent attempt to shut Russian oil off, the commodity closed today (March 10th) only $16 higher at $106.
Figure 2 below shows free cash flow yields by GICS sector. To summarize the obvious:
- Prior to the invasion of Ukraine, the world had a shortage of oil
- The West is now in an existential crisis with the world’s third-largest oil producer
- Energy stocks are still the cheapest and most unloved group in the stock market
To the degree the first chart didn’t convince you that energy stocks may have significant upside, KCR hopes Fig. 2 encourages some thoughtful reflection.
And by “thoughtful reflection,” what we really mean is: what the hell will it take for investors to provide energy stocks with the capital they need to meet the now-dire shortage of oil and gas supplies to ensure the liberal democracies of the world avoid an economic collapse? Do we not all realize that the “S” in ESG might be temporarily more important than the “E”?
As our renewables piece examining the IEA’s Net Zero Emissions research made clear: the world can wax poetic about what it wants, but our infrastructure, economies, and behaviors are a long way from making hydrocarbons obsolete. For investors looking to compound wealth by investing in companies that make a product essential to life that is in short supply, we hope you will read on.