In coming up with a topic to write about, I did what I usually do – read research reports, white papers, news reports, investor letters etc. Everything, and I mean everything, is somehow or another related to this virus. While that is completely understandable, I thought it would be nice to talk about something unrelated to COVID-19.
Yesterday I was talking to our Chief Investment Officer Charles Blankley and he brought up a topic that we’ve discussed many times over the past few years: the slow death of the energy sector. Now death may be too strong a word. There are energy companies that are alive, well and profiting. But their position in the global market is a fraction of what it once was.
The above chart shows how the weight of energy companies in the S&P 500 has changed relative to the S&P 500 index itself. Simply put, energy has been left behind. In 2008, the sector accounted for about 14% of the S&P 500. As of yesterday’s close, that number is now 2.6%. Over that same period, the S&P has gained +292% including dividends while energy stocks have lost -11.9%.
Another way to look at this is via market cap. The chart below shows the total market capitalization of the S&P 500 energy sector (orange line) vs the 4 largest stock weights in the S&P.
Apple, Amazon, Microsoft and Alphabet (Google) are each bigger than the entire energy sector. Just over 5 years ago, Energy was bigger than all 4 of these companies combined!
Nearly all of the energy sector is in some way or another hitched to the price of oil. Take a look at the sub-sectors of the SPDR Select Energy Sector ETF (XLE):
The “Integrated Oil & Gas” sector has your Chevrons and Exxon Mobil type companies – that is to say they’re relatively more diversified than some of the other parts of the sector. But the other 50% of companies are extremely levered to the price of oil. And we all know what the trajectory of that commodity has been over the last several years.
There are many reasons for the precipitous decline in oil – the move to clean energy, supply and demand changes, fracking, shale drilling etc. But the start of the collapse seemed to have taken place about 6 years ago and the sector hasn’t been the same since.
In 2014, OPEC initiated a price war with US Shale producers taking oil from over $100 per barrel to below $30 in about 18 months. The sector has never recovered and this latest rift between Saudi Arabia and Russia has caused prices to crash through the 2016 lows.
Here is a chart of the energy sector weighting in the S&P 500 overlaid on the chart above.
If 2014 period proved to be a tipping point for the industry, what will things look like 6, 12, 18 months after the current collapse?
One thing that certainly won’t help things is the amount of debt maturing in the next few years.
North American oil and gas companies have over $200 billion in debt maturing over the next 4 years. That’s about a third of the entire sector’s market cap! Sure, some can refinance that debt at today’s lower rates, but many can’t because of their now junk credit rating, making defaults inevitable. And the ones that can refinance will have drastically reduced cash flows given the razor thin margins built into today’s crude prices.
Bottom line, it may be dark days ahead for the energy sector.
What Does This Mean for the Average Investor?
OK, so the already small and shrinking energy sector is facing a crisis moment. So what? What does this have to do with my portfolio? Aside from the small weighting energy companies have in the equity indexes, the portfolio implications can be seen in commodities exposure.
If you’ve owned commodities because they were positioned as an “uncorrelated” asset to stocks and bonds, there’s a good chance that portion of your portfolio is under water. If you bought a security that tracked the Bloomberg Commodity Index 20 years ago and held it until today, you’d have lost -35.4%. Over that same time frame, the S&P 500 is up +199.2% and the Bloomberg Barclays Aggregate Bond Index is up +173.1%.
In fact, the last time the Bloomberg Commodity Index was at today’s level was march of 1976! Imagine holding an asset for 44 years and earning a 0% return!
We’ll do a deeper dive on the negatives of commodity investing at a later date, but suffice it to say the asset class hasn’t rewarded the long-term investor.
The fossil fuel energy space has been through a rough few years and the next few months don’t look any better. Defaults are inevitable, consolidation is likely to ramp up and the high yield debt markets will be something to keep an eye on as firms struggle to get their borrowing under control. Will enough capacity be destroyed in the next 12-to-18 months that prices rebound on supply concerns when the global economy ramps back up? Or is the transition to alternative energy sources dooming energy companies to irrelevance? Only time will tell.
Are we watching the slow and painful death of a once prominent industry? Is it too late for some of these companies to diversify away from oil? Maybe. Whatever happens, you can be sure the future of energy will be drastically different than the past.
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