By Michael McCarthy 

If you want average investment returns, just do what everyone else does. However, if you want exceptional returns, you must be prepared to do what others don’t or won’t do. Right now, that means taking a very close look at oil, gas and coal stocks.

This chart shows the performance of the Australia 200 Energy sector index (pink line) versus the oil price (yellow line).  Two aspects of this chart stand out. The first is that energy sector share prices are at their lowest levels in ten years .

The second is the relative performance of the energy sector compared to the oil price. The last time West Texas Intermediate Crude Oil was at prices around $40 a barrell, the index stood close to 11,000. Now, it’s at 8,500. In other words, energy company share prices are at ten year lows outright, and against the oil price.

There are reasons for these low oil prices on both the supply and demand sides of the market. Concerns about China growth weighed on markets against a backdrop of weak European demand. On the supply side, Saudi determination to drive newer, higher cost producers from the market on top of the expansion of the US shale gas industry has also pushed prices lower.

But oil and gas prices won’t stay low forever. The long lead times in developing projects and high levergae to economic conditions means oil and gas production is cyclical. The range in oil prices for the last ten years is $32 to $150. The current price is $41, much closer to the previous cyclical low than the high.

This doesn’t mean oil prices are about to boom, nor does it mean they can’t go lower. However, the current position of oil prices and energy share prices are important news for investors with time frames longer than twelve months.

In the latest sell off, much was made of “not catching a falling knife”. This ignores the fact that when share prices are lower, the potential for takeover bids increases. Not buying when a stock reaches a preferred price exposes investors to the risk that the shre price can bounce sharply. Instead of missing the first few percent, investors waiting for stability could miss the first 15% to 20%.

Investors will have their own preferences, and there are a number of solid potential investments in the sector. The question of coal versus oil and gas is a first step. Some may take the view that the lower carbon emmissions per energy unit of gas gives it the long term advantage. Others point to the ongoing attacks on coal burning as a sign the industry is at lows. Whichever investors prefer, here’s one of each:

New Hope Coal (NHC) is a “pure” coal play, owning two coal mines in Queensland and the right to explore for further coal deposits. It is ramping up production after the purchase of coal assets from Rio earlier this year.

Essentially NHC is a play on coal fired power generation. While many environmental advocates suggest the current lower coal prices are permanent as the world (magically) de-carbonises, analyts point to the potential for increased coal demand given it’s status as the lowest priced source of electricity.

Having halved between April 2014 and September 2015, NHC shares are trading just below $2. This compares favourably to post GFC peak pricing at $6 per share. Additionally, NHC’s purchases mean its leverage to anty coal price upswings is increased.

Oilsearch (OSH) is also a company that is ramping up production. Its 29% share of production from the PNG LNG facility, which will eventually run at around 7 million tonnes per annum for the next 30 years, is a company transforming project. Heavyweight partners Exxonmobil reduce operational risks, and Woodside’s backfoot takeover bifd should underpin the share price.

OSH has bounced from lows - $5.60 in August looks very attractive now the share price is back over $8.00 . While the all time high is only 25% away, the change in the undelying nature of the company could see significantly higher prices over time.