Buying Black Gold

The oil industry has historically been a source of great returns for investors. By Bo Billeaud

The oil industry has historically been a source of great returns for investors.
November 2012

Prices at the pump got you down? Well, as they say, "If you don't have an oil well, get one." And if you can't do that, how about this: "If you don't have an oil company, buy one of those."

Owning an oil company. What a thought. Makes me go all warm and fuzzy inside. Well, you may never actually own an entire oil company, but you sure can own a piece of one. In fact, if you're a long-term investor, maybe you should. The long-term returns historically offered by oil industry companies have been terrific.

But wait a moment, let's think this through - do you want to own a staid and mature exploration and production company, or would you rather invest in the wild west, boom-bust service company side of the business? Or, to put it another way, if I asked you to guess which side of the oil business - the major producers or the service companies - would have made the best investments over the last 25 years, what would you say?

Well, my first guess was that the service companies probably provided the highest return. After all, it appears to be feast or famine for them. Seems like investors ought to get compensated for that ride. But when I looked closely at the data, I discovered that my guess was wrong. And it wasn't even close.

The accompanying chart shows the long-term total return growth (a hypothetical $10,000 investment) of two of the largest E&P companies - Exxon and Chevron versus two of the major service companies that support the industry (Schlumberger and Halliburton).    
Wow, no contest. Now that's not to say that the service companies have been a bad investment. They haven't been. In fact, they've been fine. An equal investment in Halliburton and Schlumberger over the last 22 years would have grown $10,000 to roughly $76,000. But the major production companies have simply been terrific. An equivalent investment in Chevron and Exxon over the same period would have grown that same $10,000 to more than $148,000. That's a lot of fill-ups at your local station.

Why might this be? My guess is that because the major companies have a highly diversified business portfolio, there is usually at least one aspect of their business doing well at any given time. For example, following the 2010 BP oil spill, while the share price of service companies was crushed as activity in the Gulf shut down, the share prices of the major production companies held up fine. Sure, new drilling activity slowed, but existing production (and cash flow) kept on flowing. The major producers simply have an advantage that the service industry does not. And don't forget the long-term beneficial effects of the relatively high dividends paid by the large production companies. These dividends really go a long way toward enhancing total return over time.

I'll be the first to admit that we are looking at past returns. And as everyone knows, past performance does not guarantee future results. So, whether or not this disparity in total investment return of operators versus service contractors continues is anybody's guess. But this much seems clear - it's simply all good. So rather than lament rising pump prices, why don't you do something about it if you can? I'll say it again - if you don't own an oil company, buy one.

Bo Billeaud has served as president and chief investment officer of a Lafayette-based money management firm for the past 20 years.