You have to hand it to commodities: they sure know how to party.
When times are good and the music's playing prices rise and everyone is happy. However, when the music suddenly stops, investors don't wait for the lights to come on to assess the mess, they run!
That's exactly what has happened to the price of oil which has halted the party for investors who own shares in energy companies like Santos Ltd (ASX: STO) and Woodside Petroleum Limited (ASX: WPL).
Above: The fall in crude has been hard and fast. Source: Investing.com
Why has the music stopped?
It's important to understand why the party stopped to know if it's time to buy or sell oil stocks. After all, several of the ASX-listed energy companies appear to trade at attractive valuations, so now could be an ideal opportunity to be greedy while others are fearful – a classic Warren Buffett move.
The current driver of low oil prices is a text-book glut in supply meeting falling demand. According to Bloomberg much of this has been prompted by the boom in U.S. shale production which has added an extra 1.1 million barrels of oil production per day this year, while U.S. demand for oil is forecast to drop to its lowest level since 2012.
What it means for investors
Motorists may be partying at the petrol pumps, but for investors the lower oil prices mean reduced production margins and therefore a renewed focus on production costs to identify winning companies.
After such a sustained period of high oil prices (above US$100/barrel) companies can get complacent and allow costs to rise. A potentially bigger risk is if the higher oil prices are built into cost assumptions behind new or prospective growth projects which can very quickly become marginal, a point gold miners will know all too well.
Therefore growth focused producers like Senex Energy Ltd (ASX: SXY) and Drillsearch Energy Limited (ASX: DLS) which have bold drilling and exploration projects are likely to be shunned by investors as higher risk, but could also be among the best bargains if able to deliver low production costs.
Long term, the party in oil stocks could be set to get going again. Price forecasts from the U.S. Energy Information Agency (EIA) put the average Brent crude oil price at US$104 per barrel in 2014, dipping to $102 per barrel in 2015.
