Oil & gas stocks attract investors like moths to a flame and it’s not hard to see why. Get it right and you make big money very quickly (especially if you hold winners in a Stocks and Shares ISA that protects you from paying any tax on profits). Get it wrong and there’s the real possibility of losing every penny.
If you want to see just how bad things can get, take a look at Tullow Oil (LSE: TLW).
The recent plunge in the company’s value – leaving it trading on a little under 70p as I type – is nothing compared to the long-term trend. Go back almost eight years, to March 2012, and the stock was trading at over 1,500p.
So, it’s now a bargain?
Not so fast. Tullow’s now in a very sticky spot for a number of reasons: production guidance has been slashed, the company is currently rudderless following the resignations of both its CEO and exploration director, and the balance sheet is still under severe pressure, suggesting a fresh bout of fundraising is likely.
All companies experience problems. Indeed, I’d be willing to stick with a stock if there was reason to believe it might recover and pay dividends to compensate holders in the meantime. Unfortunately, the latter is no longer the case with Tullow as the dividend has now been cancelled.
There may be talk of it now being a takeover target but this should never be the sole reason for taking a position in a business. I’m steering clear.
Industry peer Premier Oil (LSE: PMO) is another energy stock I’m wary of, albeit for a slightly different reason.
As I’ve said many times before, it’s always worth keeping an eye on what short sellers are doing. For those new to the investing, these are traders that bet against a company’s share price.
Given the volatile nature of the industry, it’s not exactly surprising if a few oil stocks make the list of shorting favourites. Premier Oil, however, has recently shot to the top.
Some readers may be scratching their heads. As my Foolish colleague Rupert Hargreaves explained recently, recent production has been healthy, and investors have embraced the idea of asset disposals. On the face of it, Premier seems a different beast from Tullow.
Or is it? Like Tullow, the investment case of Premier makes sense when the price of black gold is sky-high but it’s less than ideal if it’s falling or stagnating.
This explains why a fund based in Hong Kong – Asia Research and Capital Management – has taken a massive short position on the stock as a hedge on its own $380m holding of the company’s huge debt pile. This way, it has some protection if the oil price stays low until the debt becomes repayable.
The fact that ARCM has stated that this is normal practice may help to assuage concerns, but it’s not exactly a ringing endorsement of Premier’s position. Ask yourself: if professional investors feel the need to make such a massive bet against a company they already have an interest in, do its shares truly represent the best opportunity for retail investors to make money?
If you’re tempted by either Tullow or Premier, I think the message is simple: only put cash in that you can afford to lose.
Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.