If you invested in energy stocks in 2021, it’s unlikely that you were disappointed with the outcome as the energy sector was the best performing S&P 500 sector of 2021, with a 53% total return.
Oil and Gas stocks have been rallying this year so far, and many analysts believe that energy stocks will remain a safe bet for the foreseeable future. However, with rising inflation, the conflict between Russia and Ukraine, and a host of other geopolitical factors, there could be some uncertainty on the horizon. Are energy stocks still a safe bet for retail investors?
What are Energy Stocks?
Energy stocks refer to oil and gas (O&G) companies involved in exploring, drilling and refining, plus power utility companies.
Renewable energy stocks such as solar, wind and hydrogen come under alternative energy stocks.
Utility stocks tend to make a more stable investment than O&G stocks but can still be influenced by rising energy prices. This article focuses on the headwinds facing O&G energy stocks.
What are the macro factors affecting energy prices?
There are several different geopolitical factors affecting energy prices, including:
The threat of Russia Ukraine conflict
Iran nuclear deal
OPEC + supplies
Supply chain disruption
Some of these have a temporary influence on the price of energy stocks, while others are longer-term.
What is the link between Oil & Gas prices and Energy Stocks?
When the oil price soars, it makes producing oil more feasible. Getting oil out of the ground is a costly process. Drilling offshore now involves state of the art next generation oil rigs with many millions of dollars worth of equipment. They must also employ a skilled workforce.
Shale oil drilling or fracking, which is commonplace onshore in the US, has lower rig and equipment costs but can be less efficient.
In either case, higher oil prices are good for business.
Accounting for costs, each company has a break-even price per barrel of oil that makes drilling viable. When the oil price exceeds the break-even price, there is the opportunity to profit.
That's the simplistic view, but in reality, many factors converge to influence energy prices and thus the share price of energy stocks.
Why Invest in Energy Stocks?
Energy stocks range from highly speculative explorers to decades-old established oil majors. Investing in any energy stock carries an element of risk, but it can be an excellent way to diversify a portfolio.
The larger established energy stocks, such as ExxonMobil (NYSE: XOM), Chevron (NYE: CVX), BP (NYSE: BP), Shell (NYSE: SHEL) and ConocoPhillips (NYSE: COP), all reward shareholders with generous dividends and share buybacks. This makes them an attractive addition to a long-term portfolio.
Meanwhile, share price volatility influenced by the oil price can make lesser-known companies a lucrative trade. In this instance, the risk/reward ratio is higher.
Investing in Energy Funds and ETFs
Some investors prefer to hedge their portfolios by investing in an energy fund, and Energy ETFs are a good way for retail investors to dip their toe in the water and start investing in stocks within the energy sector.
Because Energy Funds and ETFs invest in a group of companies, rather than an individual company, they are low risk, less volatile, and are excellent vehicles to gain broad exposure to a particular sector.
There are many to invest in, but here is one to consider:
Energy Select Sector SPDR Fund (XLE)
The Energy Select Sector SPDR Fund (XLE) is a popular ETF for investors seeking exposure to US energy stocks. The XLE offers liquid exposure to a market-like basket of US energy firms. This means concentrated exposure to the giants of the industry.
It includes companies listed on the S&P 500, operating in the oil, gas and consumable fuels, and energy equipment and services industries. The fund holds $35bn in assets under management at the time of writing.
In the past six months, its largest buys include ExxonMobil, Chevron, EOG Resources, Schlumberger, and Coterra Energy, while ConocoPhillips is its largest recent sell.
As far as gauging whether energy stocks make a good investment in general, the S&P Composite 1500/Energy index provides a broad indication.
S&P Composite 1500 / Energy index
The S&P Composite 1500 / Energy index shows its constituents average a price-to-earnings ratio (P/E) of 16.7 compared to the S&P Composite average P/E of 21.2.
Looking ahead, these energy stocks have an average P/E of 12.3 compared with the S&P Composite average P/E of 19.2.
Meanwhile, they offer an average dividend yield of 3% compared to 1.3% in the S&P Composite.
These metrics indicate energy stocks could still be considered cheap
The key industry players present in this index include:
Exxon Mobil Corp (XOM)
Chevron Corp (CVX)
Marathon Petroleum Corp (MPC)
Valero Energy Corp (VLO)
Phillips 66 (PSX)
PBF Energy (PBF)
Baker Hughes Company (BKR)
World Fuel Services Corp (INT)