The 12 Best Oil & Gas Stocks for Long-Term Investors

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Oil Rig
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Long-term investment outperformance in the energy sector rests on buying and holding shares in companies that have sustainable competitive advantages in their market niche. The basic investing truisms such as diversification, investing for the long-run, and buying shares at a reasonable valuation continue to apply. This guide looks first at the prospects for the oil and gas industry before building a list of companies with excellent business economics working in their favor.

Oil companies often make good investment hedges. Because the United States consumes more oil than it produces—although its production is now in a tight three-way race with Saudi Arabia and Russia—rising oil prices have historically been bad for the U.S. economy and thus the U.S. stock market. But rising oil prices are good for the profits of oil companies. Conversely, falling oil prices have historically been good for the U.S. economy, and thus the stock market, but bad for the profits of oil companies. Because changing oil prices have opposite effects on oil stocks and non-oil stocks, an investment in oil stocks can act as a good hedge within one's stock portfolio. They can help reduce the volatility of an investment portfolio, rising when other stocks are falling and falling when the others are rising.

Oil and gas sector outlook

Falling oil prices

As I write this in , oil prices have been falling for the past nine months. While predicting the future of oil prices is nearly as difficult as predicting the future of stock prices, the fall in oil prices seems to have two catalysts that will continue for a while: supply and demand.

Supply: Over the past several years there has been an increase in global oil and natural gas supply due to the United States shale gas and tight oil boom. In addition, OPEC has chosen not to cut production in response to falling prices, which would have slowed their fall. This is likely an attempt to squeeze out American, Canadian, and Russian oil producers, who have higher production costs and thus slimmer profit margins. As prices fall, American, Canadian, and Russian oil producers will become unprofitable before OPEC companies do. Economist Anatole Kaletsky argues that the likely trading range for oil going forward is $20-$50 per barrel, based on the production costs of the low-cost and high-cost producers, respectively. (In contrast, analysts at Morningstar expect oil prices to rise to $69-75 per barrel.)

Demand: The weakening global economy—especially in Europe and China—has been leading to a drop in global oil demand. This sharp drop in demand is likely most responsible for the rapid fall in oil prices that occurred in the fourth quarter of 2014. The drop in demand is also the greater threat to overall oil industry profits, because it suggests a shrinking market for its product.

An old saw in financial markets says "Don't catch a falling knife." It is inherently dangerous to invest in a market when prices are falling due to deteriorating fundamentals, as is the case with the oil industry today. When faced with falling prices, it is important to distinguish between temporary fear and deteriorating fundamentals. Temporary fear presents buying opportunities; deteriorating fundamentals do not. In the face of declining oil prices, the best option is to develop a short list of stocks to watch, but wait to invest until supply and demand are no longer pushing oil prices lower.

Headwinds for the big oil supermajors

A natural place to look for sustainable competitive advantages is in the energy industry's largest companies. The biggest publicly-traded energy companies are the big oil "supermajors," consisting of Exxon Mobil, Royal Dutch Shell, BP, Chevron, ConocoPhillips, and Total. They are dwarfed by—and face increasing competition from—the national oil companies (NOCs). This table shows the petroleum reserves of the largest NOCs (white) versus the largest supermajors (yellow):

Company Petroleum Reserves*
National Iranian Oil Company 311
Saudi Aramco 307
Gazprom (Russia) 112
Kuwait Petroleum Corporation 112
ExxonMobil 25
PetroChina 23
Pemex (Mexico) 11
Chevron 9
Royal Dutch Shell 8
BP 7
Source: The Economist * Billions of oil-equivalent barrels, 2010

The NOCs have long relied on the expertise of the supermajors in the extraction and production of oil. But in recent years some NOCs—such as Saudi Aramco—have been developing their own expertise, so they are less reliant on assistance from the supermajors. This weakens the sustainable competitive advantages of the supermajors. Also, the supermajors are facing increased competition from oilfield service companies—such as Schlumberger and Halliburton—when it comes to providing expertise to NOCs. This increased competition pushes down profits, which then hurts shareholders.

Stock picks

Investment thesis

The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.
— Warren Buffett*

Oil and gas is a commodity business. Most large companies in the energy sector, including most supermajors, have weak sustainable competitive advantages. This gives them a moderate amount of protection against competitors. Smaller oil and gas companies often have no competitive advantage at all. This leaves them vulnerable to competition. Very few energy companies have strong sustainable competitive advantages. The ones that do often have some sort of monopoly.

Midstream is where the monopolies are

In the energy sector, the types of companies most likely to have strong competitive advantages are oil and gas pipeline companies. Oil and gas pipelines have a unique competitive position. A pipeline acts like a "toll bridge" in that it has a monopoly on a particular transportation route. This monopoly allows the pipeline company to be a price setter rather than a price taker. The high cost of building new pipelines creates significant barriers to entry that protect the profits of the existing players. This unique sustainable competitive advantage is why oil and gas pipeline companies make up half of the energy sector stocks in the list below.

Pipeline companies are also relatively immune to changes in the price of oil. They are more sensitive to the volume of oil being transported, not the price per barrel. However, if falling prices cause producers to cut production, that would impact the profits of pipelines.

The list of the 12 best oil and gas stocks

Below is a list of outstanding publicly-traded companies in the oil and gas industry—with strong competitive advantages and excellent operational efficiencies—that should be great investments if their stocks are purchased at attractive valuations. It is not a suggestion that they are necessarily great investments at their current stock prices, especially since their stock prices may be very different when you read this than when I wrote it. An investing technique used by famed investor Warren Buffett is to build a list of outstanding companies and then buy their stocks only if they fall to attractive valuations. I recommend you follow a similar strategy.

This list was generated by looking at both qualitative and quantitative factors. Qualitative factors include each company's durable competitive advantage and quality of corporate governance. Quantitative factors include each company's long-term return on assets (ROA) and return on invested capital (ROIC) relative to other companies in its industry. The final list is sorted by ROIC in descending order. Click the name of any company on the list to see a chart of its long-term stock performance.

1. Core Laboratories

Core Laboratories (CLB) is a Netherlands-based oil and gas services company with the majority of its revenues coming from the United States and Canada. It is a very well-run business, with an extraordinarily high return on invested capital (ROIC), that specializes in enhanced oil recovery (EOR) services. Core Laboratories divides its operations into three business segments:

  • Reservoir Description — This segment makes up 48% of the company's revenues. It analyzes rock, fluid, and gas samples to help drillers determine both the market value and most effective extraction methods for oil and gas reservoirs. It is somewhat protected from the current industry downturn.
  • Production Enhancement — This segment makes up 43% of the company's revenues. It provides services and produces data used in unconventional drilling and hydraulic fracturing. It is the segment most vulnerable to the current oil industry downturn.
  • Reservoir Management — This segment makes up 9% of company revenues. It integrates information gathered from the other two segments to help increase oil production efficiency. This business segment has virtually no competition in the marketplace.

10-year trimmed mean ROIC: 39.18%

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Core Laboratories is rated 4 stars ("Buy") by S&P and 4 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

2. Exxon Mobil

Exxon Mobil (XOM) is the result of the 1999 merger between Exxon and Mobil, both formerly parts of John D. Rockefeller's Standard Oil Company. Exxon Mobil is the world's largest big oil "supermajor" and the only one with a strong sustainable competitive advantage. The bulk of its business consists of oil and gas exploration and production. Exxon Mobil has by far the greatest petroleum reserves of any of the supermajors. It acquired natural gas producer XTO Energy in 2010. Exxon Mobil also has ownership stakes in 31 refineries. There are over 19,000 Exxon, Esso, or Mobil branded retail service stations worldwide. Exxon Mobil is known for excellent management and efficient operations. It is one of only three U.S. companies with a AAA credit rating.

10-year trimmed mean ROIC: 25.42%

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Exxon Mobil is rated 3 stars ("Hold") by S&P, 4 stars by Morningstar, and "Underperform" by Credit Suisse. Check with your brokerage firm for the latest recommendations.

3. Imperial Oil

Imperial Oil (IMO) is a well-managed Canadian integrated oil and gas company. It is primarily involved in the extraction of oil from the Canadian oil sands in western Canada. Its average return on assets over the past decade exceeds all six of the supermajors. Imperial Oil is 70%-owned by Exxon Mobil and both companies share chemical business operations with each other. In some ways, Imperial Oil is a minature version of Exxon Mobil. Both companies earn a fairly similar return on capital. Both companies have excellent management with a focus on continual improvement and efficient allocation of capital. And both companies have their refineries integrated with their chemical plants. Imperial Oil produces 360,000 barrels of oil and oil equivalent per day.

10-year trimmed mean ROIC: 24.77%

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Imperial Oil is rated 3 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

4. Chevron

Today's Chevron (CVX) is the product of the 2001 merger between Chevron and Texaco. It is America's second largest and the world's fourth largest supermajor oil firm based on revenues. Chevron owns eight refineries and has ownership stakes in six other refineries. It acquired natural gas producer Atlas Energy in 2011. As of this writing, Chevron has had excellent stock performance over the past decade, outperforming the S&P 500 and its larger rivals in the oil industry. Chevron also has excellent management. Like all of the big oil supermajors, it faces challenging headwinds. As of this writing, Chevron sells for an attractive valuation and is likely to be a good investment.

10-year trimmed mean ROIC: 18.76%

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Chevron is rated 4 stars ("Buy") by S&P, 3 stars by Morningstar, and "Neutral" by Credit Suisse. Check with your brokerage firm for the latest recommendations.

5. Schlumberger

Schlumberger (SLB) is the biggest oilfield services company in the world. The increasing complexity of oil exploration and production makes oilfield services a growing industry. Schlumberger provides technology, equipment, and services to the global oil and gas industry. Over two-thirds of Schlumberger's revenue comes from outside North America. The company has a strong sustainable competitive advantage due to both its scale within the industry and its high customer switching costs.

10-year trimmed mean ROIC: 17.88%

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Schlumberger is rated 4 stars ("Buy") by S&P, 4 stars by Morningstar, and "Outperform" by Credit Suisse. Check with your brokerage firm for the latest recommendations.

6. Occidental Petroleum

Occidental Petroleum (OXY) is the most efficiently run company in the oil exploration and production (E&P) industry. The company's operations are heavily focused in the Permian Basin (West Texas and southeast New Mexico). In fact, the company makes up 20% of all oil production in that area. The company also has operations elsewhere in the U.S., in the Middle East, and in Latin America. Occidental Petroleum's operations are divided into three segments:

  • Oil and Gas — This segment constitutes Occidental's exploration and production operations, the core of its business.
  • Midstream and Marketing — This segment operates two pipelines, two natural-gas-fired power plants, and the company's energy marketing operations.
  • OxyChem — This is the company's chemicals subsidiary. It is one of America's leading manufacturers of PVC, chlorine, and caustic soda.

10-year trimmed mean ROIC: 16.77%

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Occidental Petroleum is rated 4 stars ("Buy") by S&P, 3 stars by Morningstar, and "Neutral" by Credit Suisse. Check with your brokerage firm for the latest recommendations.

7. Magellan Midstream Partners

Magellan Midstream Partners (MMP) is a master limited partnership involved in the transportation and storage of refined petroleum products. It owns 9,600 miles of pipelines. Most of its assets formerly belonged to Williams Companies. While most master limited partnerships (MLP) have the company ownership divided between a general partner and limited partners, Magellan Midstream Partners acquired its general partner in 2009, effectively dissolving it. This gives the company a more investor-friendly ownership structure. Like almost all the companies on this list, Magellan Midstream Partners has a strong sustainable competitive advantage.

10-year trimmed mean ROIC: 13.82%

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Magellan Midstream Partners is rated 3 stars ("Hold") by S&P, 4 stars by Morningstar, and "Neutral" by Credit Suisse. Check with your brokerage firm for the latest recommendations.

8. Sunoco Logistics Partners

Sunoco Logistics Partners (SXL) is a master limited partnership (MLP) spun off from Sunoco and now controlled by Energy Transfer Partners. Its pipelines transport crude oil and refined petroleum products. Its unique combination of pipelines, logistics, and marketing create operational synergies that allow the company to generate returns well above its cost of capital. Sunoco Logistics Partners is divided into four operating segments:

  • Crude Oil Pipeline System — This segment transports crude oil in Oklahoma and Texas with 4,900 miles of trunk oil pipelines and 500 miles of gathering pipelines.
  • Refined Products Pipeline System — This segment transports refined products with 2,500 miles of pipelines mostly in the Northeastern and Midwestern United States.
  • Terminal Facilities — This segment supports the Refined Products Pipeline System segment with 41 refined product terminals.
  • Crude Oil Aquisition and Marketing — This segment gathers, markets, and trades crude oil. Its trading activities involve buying crude oil at the wellhead and simultaneously selling it at the regional hub, while taking a small cut in between. This segment also transports oil by truck.

10-year trimmed mean ROIC: 11.89%

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Sunoco Logistics Partners is rated 4 stars ("Buy") by S&P, 3 stars by Morningstar, and "Neutral" by Credit Suisse. Check with your brokerage firm for the latest recommendations.

9. ONEOK Partners

ONEOK Partners (OKS) is a natural gas pipeline company effectively controlled by its general partner, ONEOK. ONEOK and ONEOK Partners are collectively a dominant player in the gathering and transportation of natural gas and natural gas liquids from Western Canada to the Midwestern United States. They transport almost 20% of the natural gas imported to the U.S. from Canada. ONEOK Partners is divided into three business segments:

  • Natural Gas Liquids
  • Natural Gas Gathering and Processing
  • Natural Gas Pipelines

10-year trimmed mean ROIC: 9.92%

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , ONEOK Partners is rated 3 stars ("Hold") by S&P, 4 stars by Morningstar, and "Neutral" by Credit Suisse. Check with your brokerage firm for the latest recommendations.

10. Spectra Energy Partners

Spectra Energy Partners (SEP) is one of America's largest pipeline MLPs with over 17,000 miles of natural gas, natural gas liquid (NGL), and crude oil pipelines. Its general partnership stake is controlled by Spectra Energy. Pipelines owned by Spectra Energy Partners are largely located in the eastern half of the United States. The longest ones include:

  • Texas Eastern Transmission — An 8,987 mile pipeline that connects the Gulf Coast of Louisiana and Texas to the Marcellus Formation in the Northeastern US.
  • East Tennessee Natural Gas — A 1,526 mile pipeline in the Southeastern US.
  • Algonquin Gas Transmission — A 1,129 mile pipeline in New York, New Jersey, and New England.
  • Maritimes & Northeast Pipeline — An 889 mile pipeline in the Northeastern US and Canada.
  • Gulfstream Natural Gas — A 745 mile underwater pipeline connecting the Gulf Coast to Florida.

10-year trimmed mean ROIC: 8.25%

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Spectra Energy Partners is rated 4 stars by Morningstar and "Neutral" by Credit Suisse. Check with your brokerage firm for the latest recommendations.

11. Plains All American Pipeline

Plains All American Pipeline (PAA) is a very successful master limited partnership that operates 16,900 miles of pipelines. It specializes in supplying crude oil to refineries in the Midwestern United States. Its pipelines transport 3.5 million barrels of crude oil per day—equivalent to 44% of total U.S. crude oil production. The company also operates natural gas pipelines in Canada. In addition to its pipeline business, Plains All American Pipeline operates oil and gas storage facilities and runs an oil supply and logistics business. Plains All American Pipeline has a strong sustainable competitive advantage and excellent management.

10-year trimmed mean ROIC: 8.16%

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Plains All American Pipeline is rated 4 stars ("Buy") by S&P, 3 stars by Morningstar, and "Outperform" by Credit Suisse. Check with your brokerage firm for the latest recommendations.

12. Spectra Energy

Spectra Energy (SE) is a midstream natural gas company operating roughly 22,000 miles of pipelines, mostly through subsidiaries. It owns an 84% general partnership stake in Spectra Energy Partners, a major natural gas pipeline owner and operator. It also owns a 50% stake in DCP Midstream, which is the general partner of DCP Midstream Partners. The other 50% stake is owned by Phillips 66. In addition, Spectra Energy wholly owns Union Gas, a Canadian natural gas storage and distribution company. It also operates a major midstream natural gas and NGL business in Western Canada. Overall, Spectra Energy's major operations are as follows:

  • U.S. Natural Gas Pipelines (including Spectra Energy Partners)
  • Union Gas
  • Western Canada Transmission and Processing
  • Spectra Energy Liquids
  • 50% ownership of DCP Midstream

10-year trimmed mean ROIC: 7.93%

Sustainable competitive advantage: None Weak Strong

Corporate governance and management: Poor Average Excellent

As of , Spectra Energy is rated 3 stars ("Hold") by S&P and 5 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

Disclaimers

I cannot predict the future—and neither can anyone else

The energy companies on this list face two big risks: falling oil prices and a major oil spill. The oil supermajors also face the additional risk of growing competition from national oil companies (NOCs). Predicting which stocks will do well in the future is extremely hard. That's why most mutual fund managers fail to beat the performance of index funds. Generally, I recommend investing in index funds or ETFs over individual stocks. But if you are going to invest in individual stocks, it is safest to invest in companies with sustainable competitive advantages that protect them from market competition.

Stock ownership

I own shares in Exxon Mobil.

Further reading