Market Commentary | November 18, 2021

Energy Sector Rating: Neutral

The Energy sector includes energy equipment and services, and oil, gas and consumable fuels.

Amid the ongoing global energy crisis, the Energy sector has outperformed the overall market since the COVID-19-crisis-related market lows in March 2020. Nevertheless, it is still one of the worst longer-term performers—despite crude oil trading at seven-year highs—as the clean energy movement and associated regulatory risks have loosened the sector’s historical relationship with the price of oil. As the energy transformation advances, many companies in the sector haven't ramped up capital expenditures and production along with rising oil prices, as they have done historically. The silver lining is that if there were a significant decline in oil prices, they will be less exposed to stranded assets (investment that becomes obsolete). 

Valuations in the Energy sector are attractive relative to the other sectors. Despite the strong gains in energy stock prices, they have not kept up with rapidly rising earnings expectations. This is not surprising, as investors have remained wary of the boom/bust sector and energy transition, while equity analysts found optimism amid the combination of rising oil prices boosting revenues and restrained expense growth.

Meanwhile, oil inventories have declined. With the reopening of the global economy, the recovery in demand for oil has outstripped supply by cautious producers—OPEC and U.S. producers alike—driving inventories lower. A continued decline in inventories against the backdrop of higher demand is inherently supportive for oil and potentially energy companies.

However, numerous uncertainties surround the price of oil, with the potential for renewed OPEC disagreement, slowing economic growth in China, and potentially harsh regulations related to the transition toward clean energy.

There are still many positive attributes of the sector that could spur renewed outperformance, but until the risks are alleviated and the positives reassert themselves, we think that marketweight exposure to the energy sector is appropriate at this time.

Positives for the sector:

  • Oil prices are being supported by improving demand, curtailed supply and a drawdown in inventories
  • Large, diversified energy companies have strong balance sheets and have become more disciplined with expense and investment management—though the high price of oil could erode this self-control
  • The ongoing recovery of the global economy and expansion phase of the U.S. economic cycle bodes well for the continued recovery in oil demand
  • Valuations are attractive relative to other sectors

Negatives for the sector:

  • Less cohesiveness within OPEC is causing higher volatility in oil prices
  • The strong U.S. dollar is inconsistent with recent strength in oil prices
  • Increasingly onerous regulatory environment—though implementation is likely to be measured
  • U.S. oil and gas majors have been slow to shift towards clean energy—but potential subsidies might encourage greater adoption of renewables
  • Shareholder activism has risen

Risks to the sector:

  • Easing in Iranian sanctions and increased U.S. production could increase oil supply and weigh on prices
  • OPEC discord could lead to a price war
  • Numerous risks to global growth stemming from COVID-19 or geopolitical flareups 
  • A significant rise in market volatility and rise in the U.S. dollar
  • Trend toward clean energy to reduce oil demand in the long term
  • Weakening Chinese growth could reduce oil demand

What do the ratings mean?

The sectors we analyze are from the widely recognized Global Industry Classification Standard (GICS®) groupings. After a review of risks and opportunities, we give each stock sector one of the following ratings:

  • Outperform: likely to perform better than the broader stock market*
  • Underperform: likely to perform worse than the broader stock market*
  • Neutral: no current view on likely relative performance

 

* As represented by the S&P 500 index

Want to learn more about a specific sector?  Click on a link below for more information or visit Schwab Sector Views to see how they compare. Clients can log in to see our top-rated stocks in the Energy sector.

Communication Services Industrials
Consumer Discretionary Information Technology
Consumer Staples Materials
Financials Real Estate
Health Care Utilities

 

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