Why Oil And Gas Stocks Will Continue To Outperform Solar

Oil prices are soaring and look set to continue their climb after OPEC+ failed to increase production. Meanwhile, solar energy is cheap and appears to be getting cheaper by the day. Despite the contrast between the two, it looks like oil and gas stocks are on course to outperform solar stocks. The solar sector’s most widely used benchmark, Invesco Solar Portfolio ETF (NYSEARCA:TAN), has gained 4% over the past week and 12% over the past 30 days. The industry is now focused on making panels more powerful as it continues to squeeze as much efficiency as possible out of solar tech. However, according to Xiaojing Sun, global solar research leader at Wood Mackenzie Ltd, the reduction in the cost of module prices has slowed notably in the past two years. It is now going to be cost-of-electricity reductions that provide much of the upside for solar energy. This limitation means solar costs are unlikely to drop low enough to outperform their oil and gas rivals, even if oil prices weren’t soaring higher.

The two sectors have had very different starts to the year. While TAN has pulled back nearly 15% so far this year after an epic run in 2020, the Energy Select Sector SPDR ETF (NYSEARCA:XLE) has gained 44.6% year to date, easily the best showing of any of the market’s 11 sectors. Despite this differing performance, a cross-section of Wall Street thinks both sectors still have room to run.

"I don't think it's too late to buy either of them. But if I'm going to buy it from a longer-term perspective, I'm going to favor the XLE over TAN," Piper Sandler's Craig Johnson, the firm's senior technical research analyst, told CNBC’s Trading Nation on Friday.

Energy sector deeply out of favor

Johnson says the biggest reason why he favors traditional energy stocks over their trendier upstarts is due to the fact that the sector remains deeply out of favor, and Wall Street will have little choice but to bite sooner or later given the sector’s stellar performance.

"I've had a lot of calls with institutions over the last couple days and I'll tell you that most institutions are extremely “underweight” the energy sector. With this being the best performance for the energy names since 2005, they're going to have to buy them. They will not have a choice."

Still, even though investors have lost what the Wall Street Journal describes as “tons” this year on solar and wind, they haven’t lost heart. They’re doubling down, nonetheless. 

Johnson recommended buying the XLE ETF outright or investing in individual energy stocks, highlighting top holdings ExxonMobil (NYSE:XOM) and Range Resources (NYSE:RRC).

Johnson notes that this is the third time the solar play has undergone a 26-week momentum spike, and the prior two times this happened culminated into a two-and-change-year bear market. Johnson says he would not be surprised to see that happen again.

We like Johnson’s picks and recently recommended XOM as a top dividend stock.

The United State's largest integrated oil and gas company, ExxonMobil Corp. (NYSE:XOM) is also one of the leading dividend aristocrats in the energy sector.

Related: 3 Stocks To Capitalize On The Rally In Natural Gas

Exxon Mobil Corp has been named in the Dividend Channel ''S.A.F.E. 25'' list, signifying a stock with above-average ''DividendRank'' statistics including a strong 5.52% forward yield, as well as a superb track record of at least two decades of dividend growth.

Last quarter, Exxon reported that industry fuel margins have improved considerably from the fourth quarter but still remain below 10-year-lows due to high product inventory levels as well as market oversupply.

The best part: Cash flow from operating activities clocked in at $9.3 billion, managing to fully fund the dividend and capital expenditures as well pay down debt by over $4 billion.

Meanwhile, we have also recommended oilfield services companies (OFS) as drilling activity gradually picks up.

Oilfield services companies such Schlumberger, Halliburton (NYSE:HAL) , Baker Hughes (NYSE:BKR), and National Oilwell Varco (NYSE:NOV) are now reporting that prices for their services and equipment have bottomed out, and many are now recruiting new workers.

It's a clear sign that U.S. crude production is ticking back up after a very depressing period. Indeed, for the first time since the pandemic hit, U.S. shale output is expected to rise by 38,000 barrels per day in August despite generally flat spending by oil and gas producers.

While the Fed sees GDP growth moderating to 3%-3.5% next year from about 7% this year, that is still very strong growth when you consider that the U.S. didn't have a single year with 3% growth between the 2008 financial crisis and the pandemic.

The energy sector may be out of favor and trending on the “wrong” side of a climate change war, but the market is the market, and for now, it’s dictating that traditional energy stocks will still be the best performers, even if solar and wind had a nice run and investors are still doubling down. They’re in it for the long haul, but there’s a lot of time between now… and then. 

By Alex Kimani for Oilprice.com

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