Canadian petroleum stocks can fit into your portfolio as a hedge against inflation and more. But you need to pick the best ones, using these time-tested tips

Canadian petroleum stocks are stock issues for companies that cover a range of oil and natural gas activity, from exploration to production and refining. These firms are typically headquartered in Canada, but can also explore for, produce and refine oil in other countries around the world.

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Though volatile, resource stocks can provide a hedge against inflation

The resource sector is subject to wide and unpredictable swings in the prices it gets for its products. In the rising phase of the business cycle, when business is booming, resource demand expands faster than resource supply, so resource prices shoot up. This balloons profits at resource companies. When the economy slumps, resource prices fall, and this drags down resource profits and stock prices.

In addition to rising and falling with the business cycle, however, resource stocks have a history of rising along with long-term inflationary trends. This gives them a rare ability: they provide a hedge against inflation.

Right now might be a particularly bad time to give up on resource stocks. This highly cyclical sector has gone through many booms and busts.

No one can say when the current weakness in many commodities will end, but it will end. When it does, prices of resource stocks are likely to move substantially higher than they are today.

You may feel resource stocks could languish for years. You may think it’s best to stay out of them until inflation moves up. But these stocks could give us an early warning of coming inflation. They may shoot up long before inflation revives.

Use these four key tips to pick the top Canadian petroleum stocks

Focus on stable political regions: We generally stay away from oil and gas companies operating in insecure and politically unstable regions like the Congo and Venezuela, or in countries with little respect for property rights and the rule of law like Russia or Mongolia. Energy extraction is inherently a politically vulnerable business; you can’t move the wells to another country, and local citizens sometimes believe that a foreign petroleum company is robbing them of their birthright—even though they need the foreign company’s capital and expertise to get any value out of the ground.

Look for steady production: Some of the most highly promoted oil and gas company stocks are penny stocks that have yet to produce anything. Many others must still add to their reserves, invest in production-feasibility studies, and raise a lot of money before they go into production. The prospects for most of these penny-oil properties, even though they may be in areas with production from existing wells nearby, are far from certain.

Look for longevity in reserves: When you invest in any resource stock, you need to look at how long the company’s reserves are likely to last. Those with low reserves need to have consistent success in their exploration programs to maximize the production of the wells and the surrounding area. That success is far from guaranteed.

Seek strong reserves, low production costs and mines that are already producing: Good energy company stocks have a range of oil and gas development projects, but their strong base of production cuts the risk of relying on new developments alone.

More tips on how to invest in the best Canadian petroleum stocks

Most investors could hold a portion of their portfolios in well-established and well-managed oil and gas stocks (or ETFs that hold those stocks), especially those with high-quality reserves and rising production. These companies are well-positioned to profit during periods of high oil and gas prices, and are able to at least partly offset price declines by producing more oil and natural gas.

Here are three more steps to limit your risk when you invest in energy stocks:

1. Look at the market cap of oil and gas companies compared to the estimated value of the reserves they have in the ground. Sometimes, a company’s marketing efforts are so successful that they drive the stock up too high in relation to the size of their findings.
2. Invest in oil and other energy stocks that own diversified drilling sites in multiple geographic locations where exploration has been successful in the past.
3. Buy petroleum stocks that use innovative new drilling and exploration techniques. Staying ahead of the curve will keep them in business.

Use our three-part Successful Investor approach to make the best picks—including  Canadian petroleum stocks

1. Invest mainly in well-established stocks with a history of revenues, earnings and dividends.
2. Spread your money out among most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities).
3. Downplay or avoid stocks in the broker/media limelight.

There is a “decoupling” that is happening with oil stocks, where the price of oil goes up yet the stocks themselves continue to fall. What do you make of this phenomenon?

With the rise of renewable energy sources, what do you think the future holds for Canadian petroleum stocks?