There’s Still Reason To Be Bullish On Oil Stocks

2022 has, so far, been a remarkable year for energy investors. If you own stock in the big three US oil companies which, in the interest of full disclosure I should say that I do, you are looking at some pretty remarkable year-to-date gains. You are up 57% on Chevron (CVX), 83% on Exxon Mobil (XOM), and a whopping 90% on Conoco Phillips (COP). Oh, and in case you hadn't noticed, that is in a year when the S&P 500 is down 22.8%!  That gives all of us smart people who follow Oilprice.com a chance to scream "I told you so!" at the top of our lungs, but the pressing question is where do we go from here? Should we all be selling, or is this a time to add to our positions?

If you want to sell, good luck to you. You are, as my old boss repeatedly told me, never wrong to take a profit, especially when that is a 57-90% profit in 10 months. However, there are plenty of reasons to think that as 2022 ends and we get into 2023, the outperformance of oil stocks is only going to continue.

First and foremost, those three stocks are all at or near record highs despite the fact that oil is around 30% below its year-to-date peak in March. Of course, at just under $90/barrel for WTI, crude is still above its multi-year average price but, as I said last week, there are plenty of reasons to think that a reverse is coming, and I believe it will move higher over the next few months.

Sure, there are questions about demand as central banks around the world try to rein in the inflation that their lax policies over the last decade have, if not caused, at least contributed to mightily. However, there is now a chance, just a chance, that the resilient and strong labor market in the US will keep that major market afloat despite the Fed's best efforts, and China could do a lot to offset problems as that economy emerges from the "zero covid" era.  

The thing is, though, even if demand does wobble a bit, supply is still constrained on every front. The North American rig count has increased this year, but off a low base and not by enough to fill the gap left by other supply restrictions, in part because of a political climate in Washington that is attempting to push faster towards alternative energy sources. Meanwhile, OPEC+ have been flexing their muscles, and the EU ban on Russian oil will come into full effect on December 5^th. The only one of those that looks like changing any time soon is here in the US, where an election next week could see the more oil-friendly Republicans take control of the House, and according to the most recent polls, maybe even the Senate too. 

So, unless a massive recession craters oil demand completely, crude prices will at worst hold up, if not actually climb significantly. That is why I am trading with a long bias right now; there is a limited downside and much bigger upside for oil prices. It is in that environment that Republicans, if they do take control of the House and Senate, will be trying to increase US oil output. Prices at the pump have been an attack subject for every Republican challenger to a Democratic incumbent in this election, so they will be keen to embrace a "drill, baby, drill" philosophy should they win. They will be doing everything they can to encourage US domestic producers to ramp up output, and if prices hold up, that will equate to a big boost in profits.

Some may look at the charts for the big three and think that it just can't go on forever. I mean, Exxon. For example, that was trading at below $80 back in February when crude was at about the same level as today, is now above $110. Surely, they will say, it is overvalued. That, though, involves making a common mistake when it comes to stock valuation. The nominal price of a stock is not an indicator of value. Far more important in that regard is the Price to Earnings (P/E) ratio, and the P/Es for all three big oil stocks are still way lower than the market average, despite those gains.

The average trailing P/E for the S&P 500 right now is 18.68. That is down a lot from the early year highs as you might imagine, and the P/Es of the big oil companies have actually fallen too, even as the stocks have risen. XOM's was 15.32 in March and is now 9.14. with CVX falling from 20.0 to 10.37 and COP from 21.42 to 10.44 in the same period. Does that sound like overpriced to you?

What is happening here is that oil stocks are trading on past disappointments, not current conditions, or even prospects. That has created a value gap that has yet to be closed, so with a chance of a softer landing for the global economy than many are predicting, restricted supply, and a likely friendlier political environment for US oil in a few weeks, selling here doesn't look like a good idea. Buying more, on the other hand, might just be…