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Identifying the Downside of Energy Stock

Although investing in energy company stocks offers some attractive advantages, nothing is ever a one-way street. Buying stock in energy companies has some significant negatives you need to consider; these pitfalls seem to affect the entire industry, so no one company should be hurt by them more than another:

  • Extreme volatility: Oil in particular, and commodities in general, are volatile investments. Think about the huge swing in oil prices since 2002. From a low of $18 in 2002, the price tripled in less than three years. It then surged to $147 by the middle of 2008, only to fall back to $40 in early 2009.

    The sharp drop in energy prices since 2008 put a severe strain on energy companies’ cash flows as they try to keep paying dividends while maintaining their rate of capital expenditures. The mid-2009 dividend cut by Italian oil company Eni may have been a harbinger of more to come.

  • Peak oil: Peak oil theory predicts severe oil shortages by 2030. Although that situation may be a good thing for investors, it also has the potential to radically change the industry. Some companies may do very well while others crumble.

  • Potential government intervention: State-owned oil companies hold most of the world’s oil and gas reserves, so the government can turn the taps on or off at any time.

  • Nationalization: Many oil-producing countries are fairly poor. As the price of oil increases, they want more of the money, which may strain relations between the governments and the major oil companies. In some cases, countries have gone as far as to nationalize their oil assets, as Venezuela did to Exxon Mobil in 2007. As the price of oil rises, the idea of this nationalization happening in other countries is a real possibility.

  • Global unrest: The people in the poorest oil-producing countries aren’t terribly happy with the way the oil companies have polluted their local environments and treated the people in general, and protests commonly disrupt supplies.

  • Development of alternative energies: Alternative energies, such as wind and solar power, are expected to feed some of the demand for carbon fuels, including oil and coal. Although this shift would help the broader economy, it would also cause oil prices to fall.

  • Bad press: The oil industry has been responsible for some of the worst environmental disasters and has been accused of being a major villain in global warming. This negativity may reduce demand for the company’s stock, which would be bad for investors.

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