Given the current oil price environment particularly with the geopolitical issues in Russia and Ukraine, it is natural to ask questions about whether an investor should buy energy producers.
At Baskin Wealth Management, we do not own any commodities (or commodity producers) for our clients whether they be oil, natural gas, coal, soybeans, lumber, or fertilizer. The core tenet of our investment philosophy for equities is that we believe owning great businesses will outperform in the long run. Great businesses build up competitive advantages that allow for market share gains over competitors: for example, Costco’s reputation for high quality and low prices, or Ferrari’s unmatched brand in high-end sports cars. Such businesses gain their dominant market position over time by executing on a day-to-day basis and iterating upon their business model.
None of these elements are present among commodity producers. By definition, commodity producers do not have pricing power or meaningful competitive advantages over other producers (otherwise it wouldn’t be a commodity!). Furthermore, oil prices are impossibly difficult to predict given their sensitivity to macroeconomic factors such as geopolitics, overall demand sensitivity to general economic conditions, and other supply factors. In my short career at Baskin Wealth Management, I have already seen market pundits predict “the death of oil” twice in 2016 and 2020.
As a result, even best-in-breed companies such as Canadian Natural Resources that has done a masterful job of adding incremental production at low prices have struggled to outperform the broad indices prior to the recent geopolitical events.
Because there is considerable uncertainty over the future revenues of the firm, valuation is difficult since you cannot reliably forecast cash flows with any reasonable level of precision. For the same reason, capital allocation is tricky for commodity producers because there is always a risk that the investment or acquisition is being made right before prices fall. This is further compounded by the fact that oil producers historically tend to expand production when prices are high and shrink when prices are low. As with “COVID winners”, CEOs are human and can get caught up in recent narratives at the wrong time.
Last, oil stocks are not a reliable hedge in all markets. True, the current geopolitical situation is benefiting the oil sector at the expense of the rest of the stock market, but oil stocks in both 2009 and 2020 fell as energy demand dried up with the slowdown in the broad economy.
By contrast, the management of a company like Vail Resorts has substantial ability to improve performance through improving the guest experience with investments in chairlifts and restaurants, drive attendance through window and season pass pricing and bundles, invest in digital analytics to optimize marketing, and so on. As an investment analyst, it is a much more productive use of time to study and own such businesses and their growth initiatives to gain confidence about their future prospects rather than to try (and likely fail) to predict the price of oil.
