Is the Energy Sector Growing?

July 14, 2022

Is the Energy Sector Growing?

Index Overview: The Energy Select Sector SPDR Fund (XLE)

The Energy sector Index is selected based on general industry classification defined by Standard & Poor’s 500 Composite Stock Index¹. The index includes companies engaged in oil, gas, fuels, energy equipment and services, providing an effective representation of energy sectors in the S&P 500. The index comprises 91.67% of oil, gas & consumable fuels while 8.33% of equipment & Services as of July 13, 2022. Exxon Mobil and Chevron Corporation are two companies of the highest weight in the fund, with weights of 23.48% and 21.14%, respectively².

Historical Fund Performance — One & Five Year compared to SPY³

Figure 1: One Year Performance

Figure 2: Five Years Performance

The two charts above show the recent cumulative returns for XLE and SPY. The crude oil price is included in the chart as well. In Figure 1, the one-year return of XLE from July 2021 to July 2022 outperformed SPY to a large extent. However, in the 5-year scope, the energy sector is greatly surpassed by SPY. Meanwhile, we noticed the XLE tends to move together with crude oil prices but with gaps.

What’s unique about the energy sector?

Matthew Bartolini, Head of SPDR Americas Research, and Anqi Dong, Senior Research Strategist, conducted research on the performance of different sectors during the period of recession, recovery, expansion, and slowdown. They found the energy sector did not make the top or bottom performance during any business cycle, which implies it may not be very sensitive to the US and world economy. Instead, they concluded that the geopolitical tensions of OPEC actions would play a significant role in the price⁴.

Factors driving the gasoline price

Since oil, gas, and fuel takes more than 90% of the Index, decomposition of oil price is necessary. According to figures published by U.S. Energy Information Administration (EIA), crude oil accounts for around 54% of the regular grade gasoline, as shown below⁵. Taxes, distribution and marketing, and refining cost also plays an important role in the gasoline price.

The U.S. Energy Information Administration concluded several major factors affecting the crude oil price on July 12, 2022, in Washington, DC. The main factors include Geopolitical and economic events, economic growth and expectations, and production and consumption of OPEC and Non-OPEC countries⁶. OPEC refers to the Organization of the Petroleum Exporting Countries. Members include the 15 largest oil exports and 15 largest oil producers worldwide. OPEC members produce 40% of the world’s crude oil and export 60% of the total trades internationally⁷. In short, OPEC has the economic power to control the oil supply substantially.

Moreover, the specific events will also drive the price dramatically. The COVID-19 pandemic in early 2020 and Russia invading Ukraine in February 2022 are two best examples.

Investment Insight

In March 2022, at Annual Energy Outlook 2022 (AEO2022) at the Bipartisan Policy Center, EIA administrator Stephen Nallely and Angelina LaRose presented the annual outlook of the energy sector. They made predictions for the future through 2050. The two key highlights are: 1. Petroleum and natural gas will remain the most-consumed sources of energy through 2050, but renewable energy is the fastest growing. 2. U.S. crude oil production reaches a record high, while natural gas production is increasingly driven by natural gas exports⁸. The projection of the future energy sector is shown in the two charts below:

Figure 3: Energy consumption by fuel & by sector⁹

Meanwhile, AEO2022 points out that the United States remains a net import of crude oil through 2050 and the projections remain consistent under the assumption of current laws and regulations¹⁰. For investors, this message implies that compared to tech and financial industries, where the stock price is driven a lot by firm specific characteristics, the energy sector is more regulated by regulations, suppliers such as OPEC, and demand for consumption. A macro-level analysis might be more critical for the energy sector.

Karen McKee, President of ExxonMobil Product Solutions, wrote, “Today, most U.S. refineries are running at or near full capacity. However, refining capacity has contracted in recent years due to pandemics, government policies or other economic pressures… Just as demand recovered post-pandemic, supply was further impacted by the Ukraine invasion and resulting restrictions on Russian oil supply¹¹”.

In conclusion, in the short term, EIA addressed that short-term oil price is subject to heightened uncertainty.

Resulting from a variety of factors such as sanctions on Russia, production decision of OPEC¹², etc. U.S. refineries use average 94% utilization in the third quarter of 2022, and EIA forecasts the regular gasoline price will average $4.05 in 2022 and 3.57 in 2023, while $4.73 and 4.07 for diesel prices in 2022 and 2023, respectively.

Lastly, given the unique characteristics of the energy sector, we think the oil price is at a high position currently because of the recovery from the pandemic and sanctions on Russia. Thus, in the short term, the price will likely experience a falling in price based on the current selling of risk assets in the marketplace.

But in the long term, the performance of XLE is more likely driven by the major oil-producing and exporting countries and the growth of renewable alternatives. Furthermore, investors should also remember that the events are a fundamental force causing the oil price. As a result, impacting the energy sector stock prices.

Moreover, we might see much higher Oil prices in years to come. As a result, of the current market disruption ending. In addition, a continual growth in oil demand. Lastly, one that grows Irregardless of EV adoption.