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Energy stocks: how will the worst-performing sector of the S&P 500 do in 2020?

By Connor Freitas

Energy stocks have been the worst-performing sector in the S&P 500 for the best part of a decade. Is this likely to change?

Energy stocks have had a bruising few years – and this industry has consistently been one of the worst-performing sectors on the S&P 500 of late. A contraction of 8.7 per cent in 2014 was followed by a deeper decline of 21.5 per cent in 2015. Although things bounced back in 2016, when energy was the top performer out of the index’s 11 sectors with gains of 28 per cent, further contractions of 0.9 and 18.2 per cent were recorded in 2017 and 2018.

Before you ask, no, things didn’t especially improve in 2019. Figures from Fidelity show the energy sector has lost 10.7 per cent of its market cap over the past 12 months. Compare that with the S&P 500 as a whole, which is up 22.8 per cent. So… does this mean investing in energy stocks is a bad idea? Are there reasons to be optimistic despite the gloomy figures?

What is the energy sector?

Collectively, energy stocks on the S&P 500 have a market cap of just over $3tn. Companies largely fall into one of two categories – those who provide equipment and services such as drilling rigs, and those who produce, refine, store and transport oil, gas and other consumable fuels.

Energy market analysis

According to CNBC figures from the start of December, the S&P 500 has gained more than 182 per cent since the end of 2009. Energy has been the worst-performing sector within the index for a decade and rose just 2 per cent over the same period. What gives – and what’s the energy industry outlook now?

Well, disappointingly low oil and natural gas prices have definitely played a role – with demand forecasts being cut. There have also been fears of oversupply in the market. Although the US is now one of the biggest producers of oil and gas, this is a result of unprecedented levels of investment that was fuelled by borrowing. Balance sheets are now under pressure – with prices falling and debts to be serviced, many firms simply don’t have the financial capacity to buy back shares or pay dividends.

Then, there’s the elephant in the room: the climate crisis. Major funds have come under growing pressure to divest from companies focused on the exploration and production of fossil fuels.

In December, the UN-backed Principles for Responsible Investment group warned there is a “significant risk of value loss” in the energy sector – along with other industries that rely on its output – as countries around the world pursue “an abrupt and disruptive policy response to climate change.” In a report, it forecast that these environmental policies could permanently wipe up to $2.3tn from the value of a range of companies currently found on the MSCI global index by 2025. The 10 biggest businesses in the oil and gas exploration and production sectors could lose $500bn from their market caps – that’s about a third of their current value. The authors also warned that energy market trends could see the world’s largest publicly listed coal companies effectively halve in value.

Energy industry outlook: the future

There’s little doubt that there is going to be tremendous upheaval in the industry, but this doesn’t necessarily mean that energy stocks will be battered across the board. That same report from Principles for Responsible Investment stresses that companies with a strong focus on renewables could see their valuations double over the next five years – and carmakers who have aggressively invested in electric vehicles could see their shares jump 108 per cent.

According to the International Energy Agency, oil producers need to acknowledge that they have been part of the problem but can offer solutions. Although fossil fuels continue to generate returns over the short-term, it warns that failing to address the climate crisis “could threaten their long-term social acceptability and profitability.”

Reducing the greenhouse gas emissions from the oil production is a first step that could be performed “relatively quickly and easily”, the IEA says. What’s more, the extensive knowledge and financial reserves of the energy industry could prove decisive in accelerating the deployment of renewable alternatives such as wind, and developing clean energy technologies such as carbon capture. Although some energy giants have been diversifying by acquiring businesses that specialise in electric vehicle charging and batteries, it is claimed that the industry’s total level of investment in non-core areas has barely reached 1 per cent.

As Dr Fatih Birol said: “No energy company will be unaffected by clean energy transitions. Every part of the industry needs to consider how to respond. Doing nothing is simply not an option.”

According to Goldman Sachs, energy stocks are yet to bottom out – this is only likely to happen later in 2020. This could deliver a new wave of investor optimism later this year. Analyst Brian Singer recommended that any stock selection in this sector needs to be based on criteria beyond earnings, such as the decarbonisation of the industry.

FURTHER READING: Utility stocks: is 2020 the year to invest?

FURTHER READING: Healthcare industry market predictions for 2020 and beyond

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