Good News For Energy Investors Even As Oil Prices Fall

Looking back on 2022 in energy, there is one phrase that I, and I’m sure many of you as energy investors, find comes to mind more than any other…I told you so! After a decade or so of underperformance that was sometimes for understandable reasons but sometimes had no detectable basis in logic, energy stocks got their revenge this year. XLE, the biggest energy sector ETF, opened on January 3rd, the first trading day of 2022, at 55.55. That was the lowest traded price of the entire year, with shares in the fund hitting a high of 94.71 in November.

If you are here, reading an article in a newsletter dedicated to energy investing, you probably don’t need me to tell you that, but it bears repeating, especially following a big year in 2021, and the way it was achieved tells us a lot about what to expect going forward.

The strength in energy stocks in the first part of the year made sense in a conventional way, as it came as crude soared. The Russian invasion of Ukraine impacted the supply of oil and, with global growth and therefore the demand outlook relatively strong, oil prices climbed to where crude hit 130.5 in early March, its highest level since July of 2008. It was what happened after that high was hit, though, that set the tone for the rest of the year.

With President Biden releasing massive amounts of oil from the country’s strategic reserves and Covid beginning to re-emerge in China, WTI futures gave up a lot of their gains quickly, dropping over 28% in seven trading days after hitting 130.50. XLE’s response to that was remarkably muted, with the ETF dropping less than 10% in the same time span. That was a harbinger of things to come, as energy stocks showed resilience and became less and less correlated to oil prices as the year progressed.

Oil tried to regain the highs in June, but then turned lower again and continued to fall for most of the second half of the year. As I write this, mid-afternoon on December 15th, the front month crude contract (/CL) is back right where it started the year, with the last trade being 50 cents above the first trade on January 3rd. XLE, on the other hand, is trading at just above $85, 53% above where it started the year.

So, what is going on? Why the disconnect between oil and XLE, whose direct correlation has been so reliable for so long? There are a couple of likely reasons.

For starters, not all of the US energy industry is about oil. Natural gas, for example, is an important commodity for almost all American “oil” companies and the price there has helped.

Natty took off this year, jumping to a high close to two-and-a-half times the price at which it started the year before dropping back. Even after that drop back, though, /NG is 84% higher than when it opened the year. With natty making up a big percentage of the output from US energy companies, a big gain like that will have at least partially offset falling oil prices.

Then there is the fact that XLE is not just a fund of oil companies. It includes energy-related companies of all types, and there have been good, sustainable gains in places other than oil, or even natural gas. Oilfield service stocks, such as Schlumberger (SLB), and Haliburton (HAL) have done well as high crude prices early in the year have translated to increased capex plans and therefore better prospects for oilfield services.

All of that adds up to more good news for all of us finally fat and happy energy investors. The gains in energy stocks are not based on the price of oil, but on lasting changes to the companies’ long-term prospects. If oil does go up in 2023, great, and that may well push stocks in the sector even higher, but if it doesn’t, never mind. Assuming the Russian war in Ukraine continues, there will be a floor on natty, and as the money set aside for capex is spent, oilfield services stocks should remain supported.

So, whatever oil does next year, there is a good chance that energy investors will still be saying “I told you so!” throughout the first half of 2023.