If you have asked yourself the question, “What happened to my energy portfolio?” over the last couple of weeks, I can assure you that you are not alone.
Those of us that are invested in the energy sector got kind of spoiled during the last couple of years, as the market confirmed our belief that energy in general, and U.S. energy in particular, was a good investment.
Figure 1: IYE 2 Yrs. Yahoo Finance
The above chart for the iShares U.S. energy ETF (IYE) illustrates the point. Taken as a whole, the sector has gained over 40 percent in 24 months -- not bad in anybody’s book. The reasons are well known and well publicized, consisting mainly of the boom in hydraulic fracturing and the resulting increases in production of oil and natural gas.
At the same time, alternative energy sectors have benefitted from a reduction in production costs, making them more competitive and allowing many companies, particularly in the solar field, to begin to make profits and start to fulfill their potential. Global demand, meanwhile, continues to climb as the world claws its way out of recession.
It is natural for investors, after a run like this, to begin to get a little nervous.
The very scenario that prompted them to invest has played itself out and the natural worry is that there is nothing left to gain. If you are beginning to feel that way, look at the chart again. It is an obvious observation, but you will notice that it doesn’t go up in a straight line; nothing ever does.
In the energy market, the most popular explanation for the volatility that we see is the fluctuations in the price of oil. Obviously, with an infrastructure that is still largely dependent on oil, that is a factor, but not the only one.
If we add another ETF to the chart for comparative purposes you will see what I mean. The United States Oil Fund (USO) is an ETF designed to reflect price changes in a wide range of oil futures contracts in the U.S. When that is compared to IYE, which reflects stock prices in the broader energy sector, we see that the two often correlate, but sometimes diverge.
The obvious conclusion is that there are other factors at play. The very thing that prompted most of us to invest in the first place is probably the most significant of those; production here in the U.S. and elsewhere is increasing.
You don’t need an economics degree to understand that if supply of oil is increasing faster than demand, then the price of oil will fall. That dynamic along with the nature of traded markets, has kept price rises in check even as geopolitical events have resulted in upward pressure, something I pointed out in an earlier article.
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The recent drop in the price of many energy stocks is partly as a result in the drop in the crude oil price that I predicted, but it is also down to more general stock market conditions. The broader market has also seen significant gains over the last couple of years and seems to be taking a breather after hitting new highs. The correction has been seen primarily in so called “momentum” stocks; those that have seen the greatest gains. That definitely applies to the energy sector as a whole.
It is little wonder then that your energy portfolio has taken a hit with oil prices falling and the overall stock market correcting, but you should ask yourself the question “Has that changed the overall energy outlook?” The answer to that question has to be ‘no.’
The U.S. Energy Information Administration’s Energy Outlook 2013 predicted that global demand for energy would increase by 56 percent from 2010 to 2040, and so far there is no sign that that is an exaggeration.
Alternatives and advancing technology may be increasing supply and creating short-term movements in commodity prices, but fundamentally energy is still a rapidly growing sector. The oil price will no doubt fluctuate, but from a long term perspective sheer volume will compensate for any drop and the companies that supply the world with energy look set to continue to prosper.
By Martin Tillier of Oilprice.com