If you’ve been scanning headlines in recent days, you’re probably convinced that the plunge in oil prices will result in the death of the energy industry as we know it.
True, the Energy Select Sector SPDR ETF (XLE) has tumbled 8% in less than a week. And when I reached out to Kim Forrest of Fort Pitt Capital asking whether energy is a good buy right now, she responded by telling me “never, ever try to catch a falling knife.”
But long-term investors shouldn’t swear off the energy sector. Here’s why:
1. American shale is still booming: There’s been growing anxiety in some corners that the North American energy renaissance, which has been a major driver of growth since the recession, could crumble if oil prices slide further below $70 a barrel.
Related: OPEC’s message to US shale: Drop dead
But Tom Kloza, an analyst with the Oil Price Information Service, said many shale companies can continue to be profitable as long as oil stays above $40-50 per barrel (it’s currently at $68). Production will continue to grow, even if at a more moderate pace, he claimed.
“A year from now we’re going to be producing more oil than right now, I’m confident of that,” said Kloza.
2. Consolidation nation: To be sure, it could be a bumpy ride for many energy companies in the coming months if oil prices remain depressed. Firms with heavy debt loads and light cash flow could be in particular trouble.
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But there’s also a chance that a wave of consolidation will put the industry on stronger footing going forward. That’s basically what happened in recent years in the airline industry, which is one of the top performing sectors of 2014.
“Technological improvements have lowered the break-even oil price, but there are some high cost producers that will have to evaluate whether they should sell their assets or ride this out,” said Brian Jacobsen, Chief Portfolio Strategist for Wells Fargo Funds Management.
“This is part of the natural sifting and winnowing of the industry,” he said.
3. Big oil isn’t going away: Investors such as Oliver Pursche of Gary Goldberg Financial Services are making the long-term case for buying big energy stocks like Exxon Mobile (XOM)and Chevron (CVX).
He likes these companies’ healthy dividends, along with their “rock solid balance sheets and easy-to-understand revenue streams.”
He also thinks they’re pretty cheap right now.
Exxon and Chevron are trading at roughly 13.5 and 11.6 times next year’s estimated earnings, respectively. That’s compared to the S&P 500, which is trading at around 16 times next year’s earnings, according to FactSet.
4. The world economy is growing: The glut in worldwide oil supply is partially the result of a slowing global economy. But Pursche points out that demand from many of world’s economies is ultimately going to prove stronger than the market is anticipating.
He cites the growing middle classes in China and even Africa as evidence of future expansion.
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Indeed, investors may not be so pessimistic after all when it comes to oil prices. In a note Monday from Capital Economics, the research firm noted that “while the current price of oil has collapsed, there has been little change in the price discounted in the futures market four to five years ahead.”
It’s a reminder that the medium to long term outlook is still very strong for energy.
The takeaway: Of course, things are never cut and dry in the oil market. A geopolitical crisis or natural disaster of some sort could send prices skyrocketing back up in a heartbeat. OPEC could cut production when it pleases.
In fact, it’s possible that a rebound is already underway. Oil prices rallied almost 4% Monday.
Either way, 2015 will be a volatile year for energy as all these factors play out, according to David Kotok of Cumberland Advisors.
“Investors now must do serious homework and take nothing for granted,” he said.
