One of the most popular alternative investments in the United States is commodities, especially oil and gas. Oil and gas have seen a new spike in interest as commodities prices soared in large part due to the conflict between Ukraine and Russia.
In recent years, investors have been more hesitant about these investments because of the climate crisis and growing interest in renewable energy sources. However, this may change with more people turning to oil and gas and realizing the profitability of the industry. Still, oil and gas investments come with significant risks that investors need to know before they pursue opportunities.
The Price Volatility of the Oil and Gas Commodity Markets
The biggest risk of investing in oil and gas is price volatility, which is well demonstrated by the recent gains driving investment. In 2014 and 2015, there was a significant oversupply of crude oil and natural gas. This glut caused the industry to experience sharp drops in price. Likewise, spring 2020 brought a collapse in oil prices due to the larger economic slowdown caused by the COVID pandemic. At this time, the industry saw 20-year lows. In July 2014 oil sold for $107 per barrel—in March 2020, it was selling for $20 per barrel. Natural gas prices fell as well, but it is worth noting that natural gas prices are even more volatile than oil because of the seasonality of the product. As demand increases in the winter, prices also rise, but only for a few months.
Beta is used as a measurement of the volatility of a stock relative to the overall market. The betas of the oil market tend to be significantly higher than the S&P 500, which sets the standard with a beta of 1.0. In December 2021, the beta of ConocoPhillips reached 1.61. During that time, Chevron and ExxonMobil also had very high betas.
Volatility like this means that the value of your investment will fluctuate greatly. If you are impulsive or emotional with your investments, you likely need to consider other options. Historically, however, the industry has always recovered. From the record lows of 2020, the industry is now seeing incredible highs.
The Real Possibility of an Accident Affecting Investment Value
One of the more unique risks associated with oil and gas investments is the possibility of an accident like an oil spill. When this happens, it spells disaster for a company, and its stock prices will plummet. A great example of this is the Deepwater Horizon oil spill of 2010 after which BP stock fell from $60 per share to $26.75. This disaster released nearly 5 million gallons of oil into the Gulf of Mexico and destroyed the habitats of millions of marine animals in the process. Currently, BP is still dealing with lawsuits from this incident. This risk has become more substantial because of increased connectivity and awareness. After the 1989 Valdez spill, Exxon stock fell just 4 percent, and the price recovered in a month. At that time, the spill was less publicized. Today, spills are a major news story.
Gas companies also face a lot of risk due to accidents. After all, natural gas is highly flammable and the pipelines that transport it stretch hundreds of thousands of miles. The potential for disaster is very high even if an incident does not have the same environmental impact as an oil spill. At the same time, natural gas is also toxic, so the potential for injury to humans is very high. The problem with this accident risk is that there is no guarantee of recovery. BP continues to struggle, and if another disaster occurs, then the company would likely fold. Investors should be sure that the companies they invest in take safety seriously and do everything possible to prevent a disaster.
The Potential for Deep Dividend Cuts at Any Given Time
Many companies in the oil and gas sector will pay dividends to their investors. Dividends provide investors with regular income on top of whatever gains in value the stock has over time. At the same time, it is important to know that these dividends are not guaranteed. In other words, companies can cut the dividends at any time if they are unable to raise the money required to pay them. This risk is closely related to the volatility of the market. Whenever commodity prices fall, which can be quite often, companies will earn less revenue from what they sell and thus become less likely to pay dividends to investors. Therefore, on top of stock prices likely falling, investors get hit with a cut to dividends at the same time.
A great example of this risk is Seadrill, which operates drilling rigs. The company offered large dividend payments until they were cut in November 2014 to the shock of many investors. At the same time, the price of the stock dropped more than half. Investors not only failed to receive the regular income they had been expecting from the company, but the investment itself lost a lot of value.
Investors in the oil and gas industry always need to consider the possibility of a cut to dividend payments and have a plan for dealing with this surprise. This means that investors should never come to rely on these payments.