Risk Points In Various Industries-Energy Industry
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Risk Points In Various Industries-Energy Industry

Energy industry risk points (investor must have industry knowledge)

1. Sub-sectors

Coal, atomic energy, hydropower, thermal power, wind power and solar energy, but almost two-thirds of the world's energy comes from oil and natural gas.

2. Overview of the oil and gas industry

a. Exploration and mining: Most of the energy we use comes from underground, and oil companies create value by exploring and mining these oils and natural gas. These energy sources are impossible to mine in our limited life span even to our grandchildren.

b. Oil and gas pipelines: Once the oil is mined from the ground, it must be transported to the refinery, and the refined oil can be supplied to the end-users. Oil tankers play an important role, and oil pipelines are often overlooked as important ways of transporting oil. The oil pipeline is a business that is not sensitive to commodity prices in the energy industry and is a typical very profitable asset owned by the company.

c. Refinery: Once the oil is transported to the refinery, it is also downstream of the industry. Refineries break down crude oil into different components and refine them into different end products, such as gasoline, aviation kerosene and lubricants. In the long run, the refining industry is much less profitable than oil from underground mining, and refining margins tend to be cyclical.

d. Consumers: The rest of the downstream business is marketing, which includes operating convenience gas stations and selling fuel and power products to industrial users.

e. Service Providers: The entire oil services industry is focused on providing products and services to oil companies. It is difficult for most oil service companies to create value for shareholders because oil service companies tend to be highly competitive and it is difficult to gain a competitive advantage. In addition, the financial health of this industry tends to be strongly cyclical.

3. Impact of oil prices

The rise in international oil prices can create a good performance for the exploration and mining industry, but it will offset the profits of the refining sector. However, with the implementation of the national refined oil pricing mechanism, the rise in oil prices can be partially passed on to consumers, which alleviates the abnormal loss fluctuations in the refining sector. The impact of refining on oil prices has shifted from a barrier to a limited delay.

4. Competitive advantage

a. The Organization of Petroleum Exporting Countries (OPEC) is a very influential factor in the energy industry because it can maintain oil prices above production costs. 

b. Economies of scale play an important role in the profitability of energy companies. The rate of return and the rate of return on invested capital are highly correlated with the size of the company.

5. Characteristics of successful energy companies

a. Excellent financial record: For an integrated oil company, they can make a profit even when the price of oil falls.

b. Clear balance sheet: Companies with debt-to-equity ratios below 1.0 are better investment options.

c. The reserve compensation ratio is much higher than 1.0: The reserve compensation ratio refers to the amount of newly discovered oil reserves of a petroleum company in one stage divided by the amount of oil that the company extracted during the same period.

d. The use of cash flow is beneficial to shareholders: stable companies such as major integrated companies can generate much more cash than they need to reinvest in the industry. Most good oil companies are able to pay generous dividends or buy back company stocks until they find a growth opportunity to invest.

6. Risk

a. The biggest risk is that the Organization of Petroleum Exporting Countries loses its influence in the oil market. If that happens, the long-term rate of return of the oil company will be greatly impaired because the price of oil will fall near the cost of production. 

b. The role of Russia as a major oil exporter has weakened the influence of the Organization of Petroleum Exporting Countries, and its economic situation is closely linked to the wealth of the oil industry.

c. There are also major political risks in the energy sector. There is a risk of expelling a company and the risk of an exponential increase in tax revenue, which will damage the company's assets. 

d. Some new technologies for accessing energy may change the world's dependence on oil and gas in the future.

7. Summary

Strong cyclical industry, but the peaks and valleys of the cycle will not last long (to seize investment opportunities). Exploration and mining are more attractive than refining and sales, but past oil bubbles have also been concentrated in the crude oil exploration and mining industry. The energy industry's rate of return is highly dependent on oil prices, and in the long run, rising oil prices are almost inevitable. Buying in a cyclical trough is a good idea. Choosing a company with a large economy and a well-performing balance sheet can often bring lucrative returns to investors.

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