This article is not going to tell you that money cannot be made investing in oil. Many investors have made nice returns investing in petroleum, but by the same token many have made money playing blackjack in
Photo by BarrybarVegas. Rather, this article is for the smart investor looking to make value based investments. Here are three reasons you should avoid investing in oil stocks.
1) Oil is a Cartel
OPEC, otherwise known as the Organization for Petroleum Exporting Countries, essentially operates as a legalized cartel. Monopolies may seem like assured profit generators, but they are opaque and subject to the whims of the individual countries from which the oil is drilled. Think about it. Many of the most unstable and anti-market countries are the largest producers in OPEC. Iran, Venezuela, and Libya are just a few examples. These countries will naturally look out for their own interests, but these interests are not necessarily the same as the interests of the oil companies. To an extent, oil companies are held hostage to this select group of exporting countries.
2) The Unpredictable News Cycle
Oil has been notorious for its fluctuation due to various news stories. Conflict in the Middle East invariably pushes the price higher while the death of Osama Bin Laden causes it to drop $15 per barrel overnight. With this type of reliance on the gyrations of the news cycle, oil stocks end up being extremely hard to read from a fundamental investing perspective. Violence and conflict spring up overnight and can recede from the news as quickly as it arrived. As an investor, you are looking for a degree of certainty. As recent history can attest to, current events have a way of upsetting the status quo. Believe it or not, but this can wreak havoc on your portfolio, unless you are lucky. Luck is really the prime determining factor when investing in oil.
3) Obscured True Value
The central problem with investing in oil is precisely the way in which true value is obscured. The smallest fluctuations in world events cause the price of oil per barrel to jump or fall. There is no correlation – or at least only a very weak correlation – between the real fundamental value of a company and the market price. Traditional value investing metrics like P/E, PEG, ROE, etc.. are virtually useless if the prime driver of oil markets is the news or the machinations of a small undemocratic cartel. Ultimately, Vegas probably would be a safer bet. Do your research and learn the principles of value investing and use this knowledge on sectors of the economy that can be analyzed rationally.
Finding the True Value of a company is essential to making smart investments. Because it is difficult to determine the real value of an oil stock, investing in oil can be unscientific and risky.
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