Energy sector overview
Apparent discipline among oil producers appears to have helped oil prices rise. While lackluster global growth and fuel efficiency improvements have dampened oil demand in recent years, it's possible that better U.S. and global economic growth and potential geopolitical uncertainty eventually could lead to higher oil prices.
Market outlook for the energy sector
The energy sector hasn’t kept up with the price rise of oil over the past year—a break from historical precedent and one that isn’t likely to last, in our view. In fact, over the past couple of months, we have seen the energy sector outperform and begin to close this gap. This is part of the reason why we have kept a market weighting on the group—it can be fairly volatile and change direction pretty quickly, much as we’ve seen over the past few months—with the energy sector being the best performing group. However, the Wall Street Journal reported that both Russia and Saudi Arabia were discussing raising production levels, although nothing is set in stone as of yet (May 29, 2018). This illustrates why we’re still concerned that the discipline shown on the supply side both with OPEC and here in the U.S. won’t last as companies and countries chase profits. Additionally, according to Baker Hughes, the rig count in the U.S. has started to move higher again after a brief dip.
We admit to being more cautious than others recently with regard to the energy sector, due largely to the potential risks of a sharp turnaround—much as we’ve seen in the past—but we aren’t opposed to those with higher risk tolerances looking to be modestly overweight in energy, understanding that reversals are quite possible. According the NDR, a similar divergence between oil and the sector occurred in 2002, which was followed by energy outperformance in 2003 as the sector caught up with the price of oil. Despite our caution, there remain bullish developments and should discipline among producers continue to hold—both domestically and globally, we would consider upgrading the group. To be sure, global growth has improved, with recent Markit PMI readings remaining in positive territory, 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—for now.
It is often said that the cure for high energy prices is high energy prices and we could be getting closer to that point, leading to our continued hesitation to raise the overall weighting on the group. So, for now, 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, with the notable exception of the U.S. Fed, generally appear to have an easing bias, which could help the more cyclical sectors such as energy.
- Rising geopolitical tensions: These tensions, if raised, could result in higher oil prices.
Negative factors for the energy sector include:
- New supply: Energy supply has increased dramatically with a renewed commitment to exploration and technological improvements.
- 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.
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