Energy Sector Rating: Marketperform

What is the energy sector?

The energy sector comprises exploration and production, refining and marketing, and storage and transportation of oil and gas, coal and consumable fuels. It also includes oil and gas equipment and services.

Energy sector overview

Although OPEC recently extended its planned production cuts, increased production in the U.S. appears and bloated inventories have contributed to a recent pullback. While lackluster global growth and fuel efficiency improvements have dampened oil demand in recent years, it's possible that rising U.S. economic growth and potential geopolitical uncertainty eventually could lead to higher oil prices.

Market outlook for the energy sector

At this point it’s hard to argue that OPEC’s influence on the oil market has been greatly reduced. Despite cuts that largely held, oil prices haven’t bounded in any meaningful way and the IEA is reporting that compliance with the cartel’s announced cuts was down to 78% in June, the lowest since the agreement was announced.  It is clear to us that the price driver of oil now is largely in the U.S. for the time being, with domestic oil companies able to ramp up production quickly, while they have reduced the breakeven costs, according to various energy companies’ quarterly reports (such as Exxon Mobil), in many of the oil shale fields. Additionally, according to the Energy Information Agency, commercial crude oil inventories are in the upper half of the average range for this time of year, while gasoline inventories are above the upper limit of the average range. 

Meanwhile, Libyan and Nigerian oil production has risen recently, according to the IEA, which partially offsets the cuts that have been made by OPEC. OPEC members are notorious for violating agreements according to IEA records, which we are again seeing signs of as mentioned above. We think the risk of countries backing off their production-cut commitments rises as the longer oil prices remain lower than OPEC had been hoping for. However, global growth has improved, with recent Markit PMI readings rising, which could help to support oil demand growth. But at this point we don’t think growth will rise to the point of producing a spike in the need for oil, keeping us in the marketperform camp. 

It is often said that the cure for high energy prices is high energy prices. The opposite can also be true: low energy prices can stimulate demand—resulting in potentially higher prices. Overall, we believe the factors outlined above support a rating of marketperform.

Factors that may affect the energy sector

Positive factors for the energy sector include:

  • Potential increase in energy demand: The U.S. economy is growing and developing nations will likely need more energy as they improve their infrastructure and modernize their economies.
     
  • Accommodative monetary policy: Central banks in the developed world generally appear to have an easing bias, which could help the more cyclical sectors such as energy.
     
  • Rising geopolitical tensions: These tensions, if sustained, could result in higher oil prices and improving sector performance.

Negative factors for the energy sector include:

  • New supply: Energy supply has increased dramatically with a renewed commitment to exploration and technological improvements. Additionally, the easing of sanctions on Iran should result in new supplies hitting the market.
     
  • Increased conservation: Conservation efforts and new technology could affect the growth in demand for energy products.
     
  • Energy use restrictions: Severe pollution problems in China could result in mandates to cut energy use.

Clients can see our top-rated stocks in the energy sector.

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.

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Next Steps

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