Energy companies defied the odds last year.
Despite the pandemic and the need to phase out fossil fuels to fight global warming, big energy stocks have outperformed the rest of the S&P 500.
Oil and natural gas prices, which rose 59 percent, were the main driver behind the rally in energy stocks.
But the boom was not sustainable. Although energy stocks in the S&P 500 are up about 50 percent, it has been a year of ups and downs.
“The trip there was extreme,” said Liz Ann Saunders, chief investment strategist at Charles Schwab. She warned investors thinking about intervening now to “remember the dangers of chasing the sector’s performance based on what it did last year.”
In 2021, oil prices rebounded from a decline in 2020 and rose in response to rising demand as the coronavirus pandemic eased. This fueled inflation, and consumers grumbled about higher gas station prices.
In November, President Biden led a multilateral effort that included Britain, Japan, South Korea, India and China to free oil from national reserves. OPEC Plus, a group of oil-producing countries, has agreed to gradually increase supplies. Added to the uncertainty over oil prices is the still unclear impact of the Covid-19 Omicron variant on the economic recovery. In the long term, there are serious questions about how the world can move to cleaner forms of energy, such as solar and wind power from oil, coal and natural gas.
David Lebowitz, global markets strategist at JP Morgan Asset Management, said major integrated oil and natural gas producers are working to develop renewable energy technologies to stay relevant. “They have one foot on both sides of the supply line,” he said, “so it’s a way for investors to play both sides of the story if they don’t want to commit.”
Funds investing in the energy industry tend to be dominated by these global companies. For example, Energy Select Sector SPDR, an exchange-traded fund managed by State Street Global Advisors that ended the year with $26.4 billion in assets, had a total return of 53.26 percent in 2021 after a management fee of 0.12 percent. Forty-four percent of the portfolio is invested in two companies, Exxon Mobil and Chevron.
Michael Jean, a senior analyst at Epoch Investment Partners, a New York subsidiary of Toronto-Dominion Bank, says US utilities are starting to use solar and wind turbines. “We tiptoe started investing in renewable energy through the utilities sector,” he said. “It’s a good way to make yourself known, because these toll companies are more like toll roads. They are still able to generate cash flow and pay dividends.”
The utility funds, traditionally regarded as stable income generators due to their investments in regulated utilities, posted strong returns last year. The Vanguard Utilities Exchange Traded Fund, with $ 5.6 billion in assets, generated 17.33% return in 2021 after paying a 0.1% management fee. The fund’s profitability was 2.7 percent.
The $ 4.9 billion Vanguard Energy Foundation, which once owned primarily energy companies, has channeled half of its assets into utility holdings since the end of 2020. Last year, the fund’s overall return was 27.71 percent after a management fee of 0.33 percent. According to Morningstar Direct, its yield was 3.63 percent.
What will be the demand for oil in the coming decades remains a key issue for energy investors. A recent Morningstar report predicts that global oil demand will peak around 2030 and then gradually decline. The report estimates that by the middle of this century, the global economy will consume 11 percent less oil than in 2019, largely based on a forecast that more than half of the world’s road traffic will be electric vehicles.
“We are optimistic about the introduction of electric vehicles,” said Dave Meets, director of energy and utilities research at Morningstar. In part, he said, that’s because China is subsidizing the development of electric vehicle technology in hopes of dominating that global market in the future.
But he predicted that in 2050 oil will continue to be needed for sea and air travel around the world. The batteries needed to travel long distances can be too heavy to keep ships and aircraft afloat. He added that jet biofuels from sources such as corn or waste vegetable oil are likely to be more expensive than conventional fuels.
Oil may not be the fuel of the future, but oil consumption will not disappear overnight. As unlikely as it may seem, energy companies will continue to ignore circumstances for a while.