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Why It Hurts, And Why You Should Stick With It

You probably don’t need me to tell you how oil has crashed over the past year or so.
 
Nor will it be breaking news to many of you that the share prices of companies in the sector have followed the oil price down the plughole.
 
Indeed, in my previous Collective about investing in beaten-up sectors, I mentioned how the commodity sector has been coshed to within an inch of its life!

Rubbernecking the oil crash

What you might not realise, though, is just how long and deep this particular oil price slump has been.
 
The following table based on data from a presentation by US firm Matador Resources puts the current calamity into context, by comparing it to other oil price crashes of recent times:

Year

Event

Decline in oil price

Duration of decline

1986

Saudi market share war

-67%

82 days

1988

Oil glut

-44%

295 days

1991

Global recession/Gulf War

-57%

90 days

1998

Asian crisis

-60%

484 days

2001

Global recession

-53%

290 days

2008

Global recession

-78%

119 days

 

 

Average

-60%

227 days

 

2014 –

Price war/oversupply

-60%

300 days

Having started in late 2014, the current decline is already as big as the average of the six major oil price corrections since the mid-1980s, in terms of the percentage fall in the price of a barrel of oil.
 
Moreover, at 300 days, its duration is already more than 10 weeks longer than average.
 
If you’re an investor in any energy sector companies – whether major integrated giants like BP (LSE: BP), service companies like John Wood Group (LSE: WG) or smaller oil exploration and production firms such as Tullow Oil (LSE: TLW) or SOCO International (LSE: SIA) – and you’re wondering why it hurts so much, now you know.

The only way is up

I was fortunate enough not to be holding much in the way of energy-related exposure at the start of this savage downturn.
 
Three cheers for me!
 
Well, maybe one and a half…
 
You see, I’ve since blotted my copybook – and my returns – by investing new money into the sector even as it’s continued to fall.
 
Now, you might argue that wading into a sector in this much distress is madness.
 
That doing so was about as sensible as a turkey pardoned by President Obama for America’s Thanksgiving Day waddling over to a hungry mountain lion and gobbling out at a bolshie “double or quits”.
 
And on current evidence I’d have to agree.
 
It’s been painful. Oil shares have continued to shed value like ships chucking ballast overboard as they plough towards a shallow reef.
 
However, the reason I’ve persisted is because I don’t think oil prices will stay this low forever, or even for more than a year or two.
 
What’s more, if history is any guide the subsequent bounce-back in the oil price is likely to be dramatically buoyant.
 
To return to those prior oil price bear markets, here’s what Matador’s number-crunchers say happened after the rot eventually stopped:

Year

Event

Increase in oil price one year from low

1986

Saudi market share war

79%

1988

Oil glut

58%

1991

Global recession/Gulf War

5%

1998

Asian crisis

136%

2001

Global recession

46%

2008

Global recession

135%

 

 

Average

76%

 

2014 –

Price war/oversupply

Place your bets…

It’s not unusual for markets to bounce back strongly from their depths, given how irrational despair tends to hold sway at the lows.
 
For instance, just think how the stock markets around the world surged from the bottom of the financial crisis.
 
However, oil seems to be especially bouncy.
 
And while I can’t say for certain how each company in the sector would respond to the current oil price recovering from near $40 to nearer $70 in, say, a year’s time, I am prepared to confidently predict that most of their share prices would be a lot higher than they are today.

This time it isn’t different

Of course, nobody knows for sure that the oil price will recover as strongly as it has in the past – or when – or if higher prices will stick should they do so.
 
History is never a perfect guide to investing. Past performance does not equal future performance and all that malarkey.
 
It’s possible the chorus of pessimism that has engulfed the sector just as loudly as oil bulls once cheered prices higher is broadly correct.
 
Maybe some combination of today’s factors – very low interest rates, shifting politics in the Middle East, improvements in drilling technology, alternative energy, climate change, or the many more factors I’ve heard cited – mean this time it really is different.
 
But generally it isn’t different in investing.
 
Global oil demand is still increasing, for one thing.
 
And I doubt the economics of cyclical investing have been repealed.
 
Eventually oil may have its day as one of our most vital resources, but over a billion cars on the world’s roads right now say otherwise (not to mention the other 800 million predicted  to come by 2035).
 
No, over the next year or two we’ll probably discover that the cure for low oil prices was indeed low prices, as global production is curbed, indebted players with poor prospects go bust, and OPEC’s members reassess how long they want to continue trying to support their nations on massively diminished revenues.
 
Time will tell, but given the impossibility of calling the turn, I intend to keep nibbling away at the energy sector in my portfolio.
 
I just hope it doesn’t nibble away too much more of me!

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Owain owns shares in Tullow Oil and SOCO International. The Motley Fool UK has recommended shares in Tullow Oil.