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 cuts have largely held for now, increased production in the U.S. appears to create a headwind for price gains. 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

OPEC has surprised some skeptics by largely following through on their agreement to cut production, with the group reporting roughly 90% compliance recently, as reported by Reuters, although the individual country compliance varies, with some cutting more than agreed to (Saudi Arabia), and others less (Iraq). We remain skeptical that the agreement will be followed for any real length of time, but ticked up our expected range for oil to $45–$55 barrel for the foreseeable future. That is largely in line with recent prices, but up a bit from our early December forecast. Of course, if the fundamentals change, the forecast will change.

Meanwhile, Libyan and Nigerian oil production has risen recently, according to the IEA, which could offset any cuts that do occur. OPEC members are notorious for violating agreements according to IEA records, and we’ve seen that rigs in the U.S. can be put back into operation pretty quickly. In fact, we’ve seen U.S. shale output rise as those rigs have come back online, according to the Energy Information Agency, and that number is likely to continue to rise in the near term. 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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