In my opinion you should not avoid the high-risk hardware intensive oil service companies. Instead you should construct a highly diversified portfolio of companies within all three main oil related segments as you want to take advantage of irrational pricing within all segments.
What to look for in oil related companies:
- Low P/B ratio vs. industry and history
- Some of the oil majors have stretched valuations taking the current situation into consideration. If you want to make a play on the current low oil price you should avoid expensive E&P companies. Instead look for cheap E&P companies with low production costs and low CapEx commitments. If you dare you may want to take a look at Russian E&P companies.
- Low bankruptcy risk
- There is no point in buying cheap companies if they go bust or have to restructure and dilute.
- Investors should screen for companies with:
- High cash to debt ratio vs. industry and history
- Solid equity to debt ratio vs. industry and history
- Solid interest coverage ratio vs. industry and history
- Positive or flat free cash-flow to equity
Please note that making a play on the oil industry is currently not for the faint-harted. You should expect high volatility and at times great unrealized portfolio losses. In order to make this play you have to be a patient long-term investor who can handle crazy volatility.
FYI: If you own Seadrill stocks you should probably sell and take your losses while you still can.
Oil demand vs. supply in 2035. OPEC will have to pick up the supply slack:
Source: BP p.l.c.
