Energy stocks have turned around lately, but they have been big-time laggards this year. The sector’s travails didn’t start this year; it has been struggling since about mid-2014 when oil prices turned south and didn’t settle down till early 2016.
The single most important variable driving energy company stocks is the price of oil. You are not to blame if you gave up on these stocks after repeated attempts over the last few years, with each attempt bringing more pain.
It hasn’t been easy to make money in energy stocks lately, but we can’t just walk away from a sector that accounts for the 6th highest market capitalization in the S&P 500 index out of 16 sectors in total. There are plenty of reasons to be constructive about this important part of the market.
The starting point of this discussion is to form an opinion about oil prices. Such an opinion should be informed by a clear-eyed appreciation of the supply-demand forces that drive oil prices. And that’s exactly what we are doing in this note, without overly complicating the discussion with a bunch of numbers and industry jargon.
Please keep in mind that the primary fundamental problem that has weighed on oil prices over the last two years isn’t from the demand side of the equation; it is from the supply side, with literally overflowing global inventories pressuring prices.
On the demand side, a steadily improving global economic growth backdrop is helping consumption. One can argue that eventually all of us will be zipped around town in self-driving electric cars, which will drive down the demand for fossil fuels. But that’s far out there in the future, even if one assumes that this futuristic scenario is plausible, not just for us and other developed economies but also for the faster growing middle classes of China, India, and other developing economies.
U.S. Shale Replaces OPEC
The point I am making is that you don’t need to worry too much about the demand side at present. All the issues are on the supply side of the equation, which came about when shale oil producers in the U.S. took control of the global oil complex, displacing the OPEC oil cartel from its leadership position.