The sobering United Nations-backed report on global warming last week prompted a lot of hand wringing from governments and the general public about fossil fuels. The response from investors in the oil and gas industry? A big shrug.
Shares of energy companies, which led the Standard & Poor’s 500 higher for much of the year, ended the week little changed. Oil prices rebounded from a selloff earlier in the month, despite the warnings that the world must wean itself off fossil fuels, and fast.
Investors must now weigh the industry’s soaring revenue and improving profitability against the long-term prospect of a carbon-light world. The key is how long it will take for countries to phase out internal combustion engines in the coming decades and what kind of supply and demand imbalances occur along the way.
“Investors for the most part are not buying into the sky-is-falling climate change narrative,” said Martin Pelletier, portfolio manager at Wellington-Altus Private Counsel. “There is no doubt a transition towards renewables, but the pace of that transition is what is under question.”
Energy stocks have jumped this year as oil prices bounced back from COVID-19 lockdowns and investors rotated into cyclical sectors. The energy group, which includes oil majors like Exxon Mobil Corp. and refiners like Phillips 66, has advanced 30%, beating out more expensive sectors in the benchmark like technology.
It remains to be seen if this year’s strength is a blip in the long-term decline or the start of a sustained rebound. Unlike most other sectors, energy stocks remain well below pre-pandemic levels after years of poor returns and souring sentiment over their contribution to global warming. The S&P 500 energy index now has a weighting of just 2.5% in the broader index, down from 11% in 2014.
Energy stocks face a number of hurdles, including the increasing adoption of electric vehicles and environmental, social and corporate governance investing, as well as risks to global growth from rising COVID-19 infections. The International Energy Agency on Thursday cut its oil demand forecasts for the rest of the year, citing the coronavirus surge.
The U.S. is set for a wave of investment in electric vehicles, renewable power and clean energy initiatives as part of a massive infrastructure spending bill passed last week by the Senate.
The list of problems for oil and gas companies hasn’t dimmed the allure of their stocks for some Wall Street strategists. Last week, RBC’s Lori Calvasina recommended investors maintain a higher exposure to energy and financials, despite dialing back expectations for value stocks in general. Bank of America’s Savita Subramanian’s named energy as a top pick with the potential for higher earnings and depressed valuations “the most supportive of all sectors.”
Energy companies in the S&P 500 saw revenue more than double in the second quarter, and sales growth is projected to exceed that of every other sector for the remainder of the year, according to data compiled by Bloomberg Intelligence.
Meanwhile, total cash on balance sheets leaped to $72 billion in the second quarter, up 36% from a year earlier. The S&P 500 Energy Index is trading at 16 times estimated profits over the next 12 months, while the S&P 500 sits at 22.
Energy stocks will likely face plenty of headwinds in the future, but for the time being, they appear well positioned after years of underinvestment in capital spending, according to Ryan Bushell, president and portfolio manager at Newhaven Asset Management.
“Now, you have a real supply side problem,” he said in an interview. “You’re going to continue to have earnings and cash flow that look good.”
— With assistance from Bloomberg’s Tom Contiliano.