You should always aspire to have a good understanding of the companies you decide to invest in. There will be times when Wall Street throws you a curve ball, of course, but most of the time, businesses are fairly easy to understand. The core business model is what you need to think about if you are comparing oil industry players Devon Energy (NYSE: DVN) and Chevron (NYSE: CVX). Here’s why most investors will probably want to err on the side of caution.
There are subtle differences in the quality of crude oil depending on where it is drilled, but, for the most part, it is just a commodity product. When supply and demand are out of alignment, the price of oil can rise or fall in dramatic, and sometimes swift, fashion. There are other factors that impact oil prices, too, including global economic activity and geopolitical events. Oil price volatility is the norm, not the exception.
This is likely the single most important fact investors need to know about the oil industry. Once you understand this, you can make a more educated decision about whether or not you want to own oil stocks. And if you decide you do want oil exposure in your portfolio, you can use this understanding to decide which kind of oil company you want to own.
The broader energy sector is usually broken down into three subsets. Pure-play oil and natural gas extractors fall into the upstream segment. Pipeline and storage operators, which generally charge fees based on volumes for the use of their infrastructure assets, comprise the midstream segment. And refining and chemical businesses are classified as downstream. Each segment has its own dynamics: In the upstream and downstream arenas, performance tends to be more volatile, based on fluctuating commodity prices, while the toll-takers of the midstream are generally more consistent performers over time.
Devon Energy’s a pure-play U.S. oil and natural gas producer — squarely in the upstream segment — so its top and bottom lines will fluctuate along with oil prices.
To be fair, there are things to like about Devon Energy. For example, it has an investment-grade-rated balance sheet, so it is financially strong. It has generally attractive production costs, which means it can turn a profit even when oil prices are on the low side. And it has ample opportunities for growth with around a decade’s worth of drillable inventory in its portfolio. Add in a dividend that yields nearly 4% at the current share price, and Devon Energy could be attractive to investors who have a positive outlook on the future of energy prices.
