The Federal Reserve Bank in St. Louis recently released a report speculating oil reaching $0 a barrel. They built a financial model based upon the congruent relationship between inflation expectations and the price of oil. Economists at the Fed don’t necessarily believe oil will reach that price point, but it’s worth noting, because they have used this type of modeling in past reports (July 2014 through December 2015) to predict future inflation accurately.
Recent publications have written about devalued properties in the energy sector to questioning whether or not it is a great time to get into oil. Looking back on the housing crash in 2008-09, it’s hard not to argue with the investors that scooped up properties in high-end markets for a fraction of their worth. It’s hard not to be green with envy when newspapers report another home in the United States selling at record prices. Could that be the case for oil? And if it is, what are the principles that shrewd investors should use to purchase undervalued assets?
A first option to consider is risk control. Superior investment performance has been fossil fuels trademark for years now, but what level are you comfortable with commensurate to risk? There also has to be an emphasis on the consistency of the asset, and how long there was profitability in bad and good years. It makes sense for today’s wells to be shut down, or an offshore project to be put off if the profitability doesn’t make sense. But in the case of states such as Texas and North Dakota there are opportunities.
Market efficiencies are a skill that can lead to a knowledge advantage. If you are seeking superior investment results then incorporate information that also looks at inefficiencies in the market. Where others see a bust somewhere there are gains to be made from older leases with lower costs for productivity. Oil and gas are not going anywhere, anytime soon, and with better research and information, realized gains are more likely in a market that is under correction.
Specialization is an area that offers a possible path to better investment results. A diversified portfolio works for retirement accounts, but for a down market in oil and gas the ability to invest in a single asset class of fossil fuels is a way to make sure there are no surprises. The Energy Information Administration believes oil will reach $50 a barrel by mid-2017; therefore a specialized asset class of investments in fossil fuels has the ability to take distressed assets and turn them into winners.
Oil has had its up and down, and will continue that path. If an investor has the ability to find a single energy asset class that has unrealized gains, or lower prices while holding onto them for a few years then there could be positive returns.
What about market timing? The tough part is predicting the future, and that is why it is smart for the average investor to keep their hard-earned money in safe investments such as an index fund. Buy the market, and play it safe. Why try to determine market climate or the future market for oil when there are so many variables at play? Adam Smith wrote about the “invisible hand,” of the market, and now the invisible hand has trillions of decisions happening daily. This could cause defensive energy investing, or waiting out the current downturn. Holding investments that are dropping daily in value is tough, and could lead to bankruptcy, but what if the shrewd investor considered another tool at their disposal?
We live in a world where governments own oil and gas assets. From the Middle East to Russia, China, and into Latin America, most countries don’t follow the United States model of private ownership. A tool that should be considered for investors is to consider the international scene into their fossil fuel investment decisions. When the Chinese government makes comments on U.S. presidential elections then it is prudent to take that piece of information, as part of your macroeconomic tools when pondering whether to buy, sell, or hold an energy asset.
Predictive international unrest analysis seeks to understand the complex and competitive operating environments currently taking place worldwide. Relying on wise business practices alone in an ever-changing global world seems out of date. Why not take into consideration what is happening in the Middle East, the South China Sea, and Venezuela when deciding if a shale asset in Pennsylvania is a shrewd investment? It seems better to have a reactive posture to deliver meaningful investment results in oil and gas markets that seem to change with daily news cycles.
By Todd Royal For Oilprice.com
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