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Energy Sector

Energy Sector Rating: Marketperform

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’s performance has been volatile over the past month, with investors attempting to balance production increases announced from Russia and Saudi Arabia, a US demand that allies stop using Iranian oil, trade friction, and both inventory and supply concerns. These crosscurrents keep us at marketperform for the group as we don’t know where the balancing point is for the price of oil, but believe we may be close to it. Additionally, American oil production continues to move higher, according to the Energy Information Agency, causing a bit more concern among investors. 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, as we’ve seen lately. The sector continues to lag the gains in the price of oil and according to Ned Davis Research, 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. Additionally, global growth concerns could dampen the price as trade concerns rise and could impact global activity. But at this point we don’t think growth will deteriorate to the point of producing a reduction 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 have gotten close 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.

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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