Schwab Sector Views: Drilling Down on the Energy Sector

Schwab Sector Views is our three- to six-month outlook for 10 stock sectors, which represent broad sectors of the economy. It is designed for investors looking for tactical ideas. We typically update our views every two weeks.

With the market shifting its focus to the Brexit vote and its immediate aftermath, the energy sector may finally be taking a backseat in the minds of investors. That’s quite a change from the past couple of years, when the price of oil was a primary focus of the market. But now, we’ve started to see the correlation that had emerged between oil prices and stock market performance start to diminish.

Correlation between crude and stocks may be diminishing

Source: FactSet, Dow Jones & Co., Standard & Poor's. As of Jul. 19, 2016.

While it may not seize the market's attention the way it used to, the energy sector remains important. Much of the global economy depends on  access to oil, and also its price. And we've seen oil prices move considerably in the past two years, from more than $100 per barrel, to less than $30, before settling  toward the $50 level today. Amid the volatility, debates raged about whether the plunge in prices was attributable to an increase in supply, or slackening demand due to an impending global recession. We heavily leaned toward the former and believe that has largely proven to be true—but where do prices go from here?

We’ll get to the punchline first. It appears to us that the oil market is more in balance and that a price range of $40-$50 seems reasonable for the near future, which is the range we’ve seen since mid-April. Of course, there can always be exogenous events that could greatly impact the price of oil relatively quickly and severely, as we’ve seen throughout history. But for now, we’re seeing signs of more balance. First, following the fall in crude prices, we saw the number of oil rigs operating fall sharply, and that trend appears to be leveling off.

Rig count is starting to look like a more balanced market

Source: FactSet, Backer Hughes, Inc. As of Jul. 19, 2016.

The initial sharp drop in oil prices was largely brought about by the increase in U.S. supply and the lack of response by OPEC. The supply in the U.S. was bolstered greatly by an increase in so-called fracking of shale, which unleashes oil and gas trapped in rock. The efficiency of fracking has improved by 400% since 2008, and the average breakeven price for drilling shale oil has dropped from roughly $80 to around $50, with a move to $40 possible in the future.1 Technological improvements are also shortening the time it takes to drill wells. Eight years ago it took Continental Resources a month to drill a well in the Bakken Shale area, while last year it took 18-20 days and now it takes only 13-15 days.2 These technological improvements in the oil arena appear set to continue, in our view, which should help keep a lid on prices.  

The other major part of the supply equation is OPEC, led by Saudi Arabia. In contrast to much of the past few decades, the ability of OPEC to greatly influence the price of oil seems quite limited. In fact, the cartel itself seems to be increasingly an organization in name only. But Saudi Arabia remains a major player. To this point, Saudi Arabia has been willing to keep pumping oil in spite of the glut in supply, believing it could outlast U.S. suppliers in a low-price environment, and regain some of its dominance. But we have started to see some cracks there, as budget deficits have risen. The National Bank of Abu Dhabi projects a 326 billion riyal deficit for 2016 and revenue of 514 billion. We’ll see if the need to address burgeoning deficits forces the country to try to constrain the supply of oil and raise oil prices, but for now it seems that Saudi Arabia is content with the status quo. The Saudi energy minister recently noted that he believes the oil market is becoming more in balance and that prices are stabilizing.

So the supply situation seems to us to be relatively stable at the $40-$50 range for now, with producers able to add supply relatively quickly should prices start to rise. Meanwhile, growing demand could help to support prices at current levels. U.S. drivers set a new mileage record in 2015, according to the Department of Transportation, and through March 2016, miles driven were 5% higher than through the same time a year ago.

Americans are driving more

Source: FactSet, U.S. Dept. of Transportation. As of Jul. 19, 2016.

And demanding more crude

Source: FactSet, Oxford Economics. As of Jul. 19, 2016.

And global demand seems set to remain relatively healthy, with OPEC forecasting 2017 oil demand to grow 1.15 million barrels according to Reuters, which roughly coincides with the International Energy Agency's estimates of a 1.3 million barrel demand increase next year.

So where does that leave us? With a marketperform rating and a belief that the energy sector will calm down a bit over the next several months. For now, it appears to us that demand growth is relatively healthy, and that shale producers need a price of roughly $40-$45 per barrel to keep drilling and meet that demand. If investors have shied away from this group for any reason, we suggest taking another look. The sector will likely remain more volatile than most others, but to a lesser degree than the past couple of years. And in a world where investors are  hunting for yield, a dip into the energy sector may be worth a look, as the dividend cuts we saw in the aftermath of the plunge in prices seem to have leveled off along with the price of crude, resulting in some nice yields available within the energy sector.

Schwab Sector Views: Our current outlook

Sector

Schwab Sector View

Date of last change to Schwab Sector View

Share of the
S&P 500 Index

Year-to-date return as of 07/19/2016

Consumer discretionary

Marketperform

07/17/2014

12%

4.46%

Consumer staples

Marketperform

05/07/2015

11%

11.44%

Energy

Marketperform

11/20/2014

7%

17.07%

Financials

Outperform

05/07/2015

16%

0.20%

Health care

Marketperform

12/13/2012

15%

3.57%

Industrials

Marketperform

01/29/2015

10%

11.47%

Information technology

Outperform

04/29/2010

20%

4.44%

Materials

Marketperform

01/31/2013

3%

13.10%

Telecom

Underperform

09/12/2013

3%

25.86%

Utilities

Underperform

05/23/2013

3%

22.30%

S&P 500®  Index (Large Cap)

 

 

 

7.14%

Source: Schwab Center for Financial Research and Standard and Poor's as of 06/30/2016.

Clients can use the Portfolio Checkup tool to help ascertain and manage sector allocations.

What is Schwab Sector Views?

Schwab Sector Views is our three- to six-month outlook for 10 stock market sectors, which are based on the 10 broad sectors of the economy.

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 rest of the market.
  • Underperform: Likely to perform worse than the rest of the market.
  • Marketperform: Likely to track the broad market.

How should I use Schwab Sector Views?

Investors should generally be well-diversified across all stock market sectors. You can use the Standard & Poor's 500 allocations to each sector, listed in the chart above, as a guideline.

Investors who want to make tactical shifts in their portfolio can use Schwab Sector Views' outperform, underperform and marketperform ratings as a resource. These ratings can be helpful in evaluating and monitoring the domestic equity portion of your portfolio.

Schwab Sector Views can also be useful in identifying stocks by sector for potential purchase or sale. When it's time to make adjustments, Schwab clients can use the Stock Screener or Mutual Fund Screener to help identify buy or sell candidates in particular sectors. Schwab Equity Ratings also can provide an objective and powerful approach for helping you select and monitor stocks.

1 Rich Karlgaard, "Long Boom in Cheap Energy," Forbes, 6/21/2016.

2 Gillian Rich, "New Ways the U.S. Can Squeeze Its Oilfields—And Its Rivals," Investors Business Daily, 6/17/2016.

Next Steps

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