Why Oil Stocks Can't Protect You From Gas Hikes

Photograph by Jewel Samad/AFP/Getty Images

The next time you’re grinding your teeth while filling up at the gas station, you may wonder if buying oil stocks is a good way to offset all that money pouring out of your wallet and into your gas tank. It’s a tempting proposition—but a complicated one.

Higher gas prices don’t necessarily translate into more revenue for oil companies. For one, higher prices tend to lower demand and lead to less driving. Cumulative miles traveled in the U.S. fell 1.2 percent in 2011. There’s also not a perfect correlation between oil prices and oil company stock prices. In the first two months of this year, the prices of gas and crude oil have both risen by more than 10 percent, and yet the stock prices of the three biggest oil companies by market cap—ExxonMobil, Royal Dutch Shell, and Chevron—are all flat to down in 2012.

Since gas prices can rise for different reasons, oil company stocks tend to be more strongly correlated with the broader stock market than with oil prices, says Joe Davis, chief economist at investment management firm Vanguard. If the rise in oil prices is driven mostly by rising demand, oil stocks usually rise. But that’s not what’s happening here. Over the last six months, analysts believe that more than half the rise in oil has been due to supply concerns around the Middle East, and “that’s where the correlation breaks down,” says Davis.

Still, energy stocks on the whole are still having a good start to the year, particularly those that capture the boom in U.S. oil production and refining. John Dowd runs the $2.5 billion Fidelity Select Energy Portfolio, which holds mostly U.S. energy stocks and is up nearly 12 percent this year. While Chevron and Exxon are Dowd’s two biggest holdings, his top 10 also includes refining companies such as Marathon Petroleum, and those involved in drilling and exploration technology, such as Halliburton and Schlumberger. “U.S. onshore oil production is growing for the first time since the 1970s,” says Dowd. “Having these companies positioned next to a growing source of production rather than one that’s falling is making a huge difference.”

One of the main reasons people buy oil stocks is for the dividends they pay, which look increasingly attractive against low bond yields. Exxon currently pays a 2.2 percent dividend yield; Chevron’s is 2.9 percent. The yield on the 10-year Treasury note is 1.97 percent.

Trying to defray all your gasoline expenses through the dividend yields of oil stocks isn’t exactly practical. Dowd lays out the following calculation: Say you drive 12,000 miles a year in a car that gets 20 miles to the gallon. That’s 600 gallons of gas, which at $4 a gallon, comes to $2,400 a year. Assuming a 3 percent dividend yield, it would take an $80,000 investment in oil stocks to defray your total gas expense. Not exactly a wise, or plausible, strategy for most Americans.

Dowd suggests using dividends to defray the increase in the price of gas, rather than the entire bill. That still requires a big position. If you think gas is going to rise by a dollar a gallon, assuming you use 600 gallons a year, you’d still need a $20,000 investment to offset the $600 annual increase with the same 3 percent dividend yield.

Despite oil company stocks lagging the broader stock market over the last two months, in the long run Dowd believes owning shares in the big integrated oil companies will pay off. “They’re very good at managing risk and over the long term delivering price increases down to their bottom line,” says Dowd.

The trick is figuring out how to make higher gas prices flow down to yours.

Before it's here, it's on the Bloomberg Terminal.