Energy Sector Rating: Marketperform
Energy sector overview
Global growth worries, combined with oversupply concerns in the oil arena, have appeared to weigh on the energy sector. Geopolitical events are unpredictable and often impact the energy sector, which should be taken into account along with the fundamentals of the group.
Market outlook for the energy sector
The energy sector has had rough few months, being the worst performing sector in the S&P 500® index over that period, although it has performed better to start the year. Reports in The Wall Street Journal that Saudi Arabia looked to be set to cut production more than initially thought appear to help the price of crude stabilize, at least temporarily. Also, global growth concerns that also likely played at least a minor part in the recent pullback may be easing as China has cut reserve requirements for its banks (Financial Times) and the U.S. Federal Reserve has been more dovish, in our view. But supply concerns are still hovering in the background, in our view, with the U.S. Department of Energy reporting that 2018 ended with U.S. production at 11.6 million barrels per day (mbd), up from 9.7 mbd at the end of 2017.
Taking a little larger view, the energy sector’s performance has been volatile over the past year, with investors attempting to balance a U.S. 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.
We admit to being more cautious than others regarding making a call one way or the other on the energy sector, due largely to the potential risks of a sharp turnaround—much as we’ve seen in the past. However, we aren’t opposed to those with higher risk tolerances looking at some of the higher-quality companies in energy when the selling gets to extreme points, such as toward the end of last year, understanding that reversals are quite possible, such as we’ve seen over the past year.
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, especially if we could see a good China/U.S. trade deal in the relatively near future. Additionally, global growth concerns could dampen oil prices as trade concerns rise, and could affect 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.
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.
- Rising geopolitical tensions: These tensions, if raised, could result in higher oil prices.
- OPEC has agreed to cut production, with The Wall Street Journal reporting that Saudi Arabia may go beyond the agreed-to cuts.
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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