How To Play The Energy Market In 2021

As happy as we all were to bid adieu to 2020, it has quickly become obvious that just flipping a page on the calendar wasn’t really enough to make things better. The year is but a week old, and we have already seen record Covid infections and deaths in the U.S. and an unprecedented attack on the Capitol Building by a mob. Despite all that, though, the stock market and, more relevant here, the oil markets, have had a strong first week of the year. Can that continue, and if so, how can energy investors best take advantage?

The answer to the first question is yes, at least when it comes to oil and energy, and at least for a while.

The stock market as a whole certainly looks to be fully valued at best. We are hitting new highs, even as the evidence begins to show that December marked a big reversal in the recovery from the March shutdowns as Covid regained ground. That doesn’t mean that we are about to collapse, but it does mean that the anticipated growth that is already priced into stocks will probably be delayed. That in turn suggests that upside in the broad market will be limited for a few months.

Still, on a relative basis, stocks are the place to be. Even with the recent bounce back in yields, the 10-Year will get you around 1% a year, and you can easily beat that with dividend-paying stocks that also offer the possibility of capital gains. Yes, they are riskier, but is buying stock in a solid company with a good balance sheet that pays a 5% or so dividend 5x riskier than lending to a government that is over $27 trillion in debt?

So, there will be money looking for stocks to buy. But, with the economic growth outlook uncertain for a while, the growth stocks, and sectors such as big tech that have driven the gains for a while will have much less appeal. Conventional energy stocks, on the other hand, which have lagged the indices, have some catching up to do. They also offer some juicy dividends, so will be in demand as both value and yield become more and more desirable.

Then there are alternative energy stocks. The situation there is completely different, as they have stormed higher after the election in anticipation of a radical shift from Democrats away from fossil fuels. Given that the Senate will be finely balanced, giving moderates and oil industry supporters such as Joe Manchin from West Virginia a lot of power, a really radical shift is unlikely. Still, the narrative alone should be enough to maintain upward momentum for solar and wind power stocks for a few months.

It seems, then, that everything is pointing to a good start to the year for energy, but that can only really be maintained if crude prices keep rising, or at least don’t collapse again. Fortunately, that is very likely.

The key here is supply.

The OPEC+ cuts are still in place and this week’s announcement by the Saudis that they intend to cut output even more than required hints at a determination to make them work. That makes sense because now more than at any time since they began, they can have a real impact.

Massive amounts of wells were shuttered in the U.S. and Canada last year as prices collapsed and re-opening them will take some time. Meanwhile, even if slowed by a resurging pandemic, demand for oil is recovering. As a result, crude stocks have declined significantly since the storage issues that caused negative pricing back in April.

Also, somewhat counterintuitively, the Biden administration will be good for oil prices for a while. Their most likely moves will be increased environmental regulation which will slow the re-opening of shuttered rigs, make transportation harder, and otherwise restrict supply.

Now that WTI has broken above $50 and consolidated, there are many that believe we will be in a new range of $50-65 for some time. That may or may now turn out to be the case (my trader’s brain just doesn’t think that far ahead), but for now, the path of least resistance is still upward.

As to how to play that possible strength, there are a couple of tactics to keep in mind. Because of better value metrics, I prefer oil over alternatives, and, within that, I prefer upstream over mid and downstream. The potential regulations will hurt pipeline development, and rising prices mean falling crack spreads, limiting downstream profits. E&P companies, on the other hand, can reap immediate benefits from higher oil prices.

However you choose to play it, though, it seems likely that, barring another unforeseen catastrophe, 2021 will truly be a happy new year for energy investors.