The market is supposed to change supply to meet changes in demand, yet the oil market appears to be breaking the mold. The price of oil and the number of drilling rigs has skyrocketed, yet oil production has only increased by a small amount. If you want to safeguard your energy investments you need to recognize the difficulties that the energy market is going through, and the lack of straightforward solutions.
US Crude Oil Rotary Rigs in Operation data by YCharts
The Basics
It is very unlikely that the world will physically run out of oil, but there is a good chance it will run out of cost effective oil fields. Data from the Energy Information Agency shows that cost of drilling new wells has skyrocketed in recent years. Larger oil companies still enjoy profits from older fields, but as they replace their reserves and bring new fields online, their margins are under pressure.
While alternative fuels like algae based biodiesel have to wait years before they will be profitable, there are other ways that people are dealing with increasing oil exploration costs. Some investors have decided to pony on the Tesla Motors Inc (NASDAQ:TSLA) train. Rising sales of its electric cars and a growing network of charging stations are making the company a hot growth story.
Tesla Motors Inc (NASDAQ:TSLA)’s problem is that it is a small fish in a big pond. It doesn’t have the resources of the bigger car manufacturers. Tesla Motors Inc (NASDAQ:TSLA)’s small size has forced it to focus on pure electric vehicles, thus limiting its sales prospects.
The luxury vehicle market is alive and well, but that doesn’t mean that the company should be trading at a price to book (P/B) ratio around 92 and a price to sales (P/S) ratio around 16. In comparison, GM offers hybrids and traditional cars. It trades at a P/S ratio around 0.33 and a P/B ratio around 1.8. Also, Tesla Motors Inc (NASDAQ:TSLA)’s balance sheet is questionable with a total debt to equity ratio of 2.7.
Outgrowing Oil Is Not Easy
BP plc (ADR) (NYSE:BP) is a major British petroleum firm that has dabbled in green energy. The problem is that these assets have not proven to be very profitable. It has been hard to for the company justify substantial investments in renewables when it is able to able to generate a return on investment (ROI) of 13.6% from a mainly petroleum based portfolio. After BP plc (ADR) (NYSE:BP) sold its solar assets, it recently announced it is going to sell billions of dollars in wind assets.
BP’s recent oil spill in the Gulf of Mexico took a big hit on the company, and it was forced to sell a number of its precious oil fields. BP’s debt load is healthy with a total debt to equity ratio of 0.36 and a quick ratio of 0.9. The company has decided to exit renewable energy just as solar is becoming cheaper than traditional resources. The company put its money into clean energy before the time was right, and now it looks like BP plc (ADR) (NYSE:BP) is walking away too soon.
Total SA (ADR) (NYSE:TOT) is a major French oil company that also sunk funds into renewable investments, but it has decided to stay the course. In recent years it accumulated a majority position in the solar manufacturer SunPower. SunPower is expected to return to profitability this year, proving that oil and gas companies can make smart investments outside of petroleum.
Total SA (ADR) (NYSE:TOT) owns around 65% of SunPower, but the stake is only worth a little more than $2 billion. With a market cap around $120 billion, Total SA (ADR) (NYSE:TOT)’s interests in the solar industry form a very small portion of its assets. It continues to expand its operations in Uganda and Nigeria. The company’s ROI of 9.3% and profit margin of 4.4% are rather low. It is better to buy Total SA (ADR) (NYSE:TOT) as a forward looking oil giant that is willing to make the transition to alternative fuels than as a highly profitable oil company.
Conclusion
Higher prices simply are not leading to the supply increases that the oil industry is hoping for. Sinking all of your investment dollars into genetically engineered algae or Tesla Motors Inc (NASDAQ:TSLA) is a very risky proposition. Investing in Total SA (ADR) (NYSE:TOT) offers a good compromise between both worlds. Unlike BP, Total SA (ADR) (NYSE:TOT) has been able to make profitable investments in the solar industry while it continues to grow its oil business.
The article Is the Oil Market Broken? originally appeared on Fool.com and is written by Joshua Bondy.
Joshua Bondy has no position in any stocks mentioned. The Motley Fool recommends Tesla Motors and Total SA. (ADR). The Motley Fool owns shares of Tesla Motors. Joshua is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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