How to Make Oil Stock Volatility Work for You
With oil prices rising and falling dramatically, it can be difficult to keep oil inventories under control. A strategy: buy only the most and least volatile stocks.
This may seem like a strange way to bet on a highly volatile energy market. Oil prices jumped 45% to $130 a barrel on March 6 from $89 on February 10, the day before US National Security Adviser Jake Sullivan announced that the Russia would attack Ukraine, but they fell 27%, to $95, before falling back to $103. . This drop also sent oil stocks into a tailspin, with the
Energy Select Sector SPDR
exchange-traded fund (ticker: XLE) dropping as much as 7% since then before rebounding. Oil stocks have a lot to gain if crude prices can rebound, and a lot to lose if they continue to fall.
This is where a “beta barbell” strategy comes in. Beta is the term used to measure the volatility of one asset relative to another, and Goldman Sachs analyst Neil Mehta suggests buying energy stocks with the highest and lowest betas, and ignoring everything in between. . The idea: If oil prices rise, high-beta stocks will outperform, giving a portfolio a big boost. But if the price of crude falls, the lower beta socks will provide some ballast and cushion the downside.
“Given the highly volatile commodity price environment, we continue to recommend a beta-dumbbell strategy and prefer companies where we see dislocations on valuation versus asset quality and where a higher FCF of the current bull cycle may generate higher capital returns relative to consensus expectations,” Mehta wrote. He prefers
Pioneer of natural resources
(FANG) for low beta, and
(AR) for the riskiest part of the portfolio.
Dow Jones Market Data Group selected the companies that moved the most and the least when oil prices rose or fell 1% over the past year.
(KOS) was among the most volatile stocks, moving an average of 0.8% every time oil prices moved 1% or more. This makes sense: Kosmos has more debt than its market capitalization, which makes it particularly sensitive to changes in oil prices.
Kosmos is risky, but that doesn’t make it a bad bet. According to FactSet, the company’s earnings estimates have risen 26% since Feb. 28, but they could rise further. Consider: Sales estimates are expected to rise about 36% if crude returns to recent highs — and since oil companies have a lot of fixed costs, earnings estimates are expected to outpace that increase. If oil rose to $130, “Kosmos earnings would increase by more than 40%,” says Panmure Gordon analyst Ashley Kelty. Already, the stock is up 12% from its low point during the recent oil swoon. If oil can recover $130 a barrel, “I would expect more upside,” he says.
(COP) would be a good choice for the low-risk portion of the portfolio. It moves an average of just 0.4% when oil moves 1% or more, thanks in part to a debt burden of less than 10% of its enterprise value. Moreover, its earnings estimates have risen 18% since the end of February. “Many more earnings revisions are likely to come,” said KeyBanc analyst Leo Mariani.
It’s less exciting than Kosmos, but the downside risk is also much lower. If oil falls to pre-Russian invasion levels, ConocoPhillips shares would also fall, he says. This would mean a loss of only 7%, while the level before the Russian invasion of Kosmos is 33% lower than its current price.
Low risk? High risk? We’ll take a portion of each.
Write to Jacob Sonenshine at [email protected]