Why the energy sector is about to take a tumble

Written by: Michael Harris
April 3, 2020
  • The energy sector is the worst-performing sector in 2019 and in the previous decade
  • Heavy borrowing in the past decade hasn't helped the energy companies
  • Analysts are pessimistic about the future outlook for energy sector

The end of 2019 is marked with another stock market rally as the biggest indexes are hitting record highs. The S&P 500, a major US stock market index that is considered one of the best representations of the U.S. stock market, has increased in value by nearly 33% this year following a fresh all-time high set yesterday. 

2019 performance 

Broken down by sectors, the Information Technology industry (IT) has grown more than 50% on an annual basis and it is the standout performer. Elsewhere, Financials and Communication Services have grown 32.03% and 32.80% respectively. 

2019 sectors performance (Source: Fidelity) 

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As seen in the chart above, the Energy sector is by far the worst-performing sector in 2019 as it managed to gain “only” 7.49%. This is despite the fact that the United States is now the biggest producer of both crude oil and natural gas. 

The Energy sector is comprised of companies whose businesses are engaged in exploration, production, marketing, refining and/or transportation of oil and gas products, coal and other consumable fuels.

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Past performance 

The continuous under-performance of this sector is not a novelty to investors. According to Raymond James, a US-based investment bank, this year will mark the eighth year in the last nine that the energy sector under-performed the rest of the market. Similarly to the 2019 performance, the Energy sector is by far the worst-performing sector of all S&P 500 sectors listed in the picture above in the last decade. 

“That’s pretty bleak,” said Pavel Molchanov, an energy analyst at Raymond James.

(Source: CNN)

One of the main factors that explains the under-performance of energy stocks is heavy borrowing, which left companies without funds to invest elsewhere. Furthermore, low oil and natural gas prices didn’t help the cause. 

“Shale oil companies were a victim of their own success… They produced so much oil that they stepped on themselves.”

said Bob McNally, president of consulting firm Rapidan Energy Group. 

Future outlook

In investing, there is a saying that “what doesn’t go up, goes down.” The energy sector has failed in rallying during the past decade, which has delivered some of the best stock market returns in history. As a result, this sector is extremely vulnerable to any stock market losses that may occur in the next year. A tumble of the energy sector won’t surprise many. 

Moreover, climate change is likely to play a bigger role in the next decade as well. Naturally, many analysts and investors believe that the increased awareness of climate change is likely to limit hunger for oil and natural gas stocks.

“The energy names are almost viewed as a class of vice stocks like alcohol and tobacco. That perception has created a negative pall over the whole sector. I don’t know how you overcome that”

said Ben Cook, portfolio manager at BP Capital Fund Advisors.

While we can’t predict the future, the combination of poor cash holdings, a decade of under-performance, low oil, and natural gas prices and climate change will most likely result in the continuous poor performance of this sector in the future.