The U.S. energy sector consists of three types of companies that include upstream (involved in the exploration and production of oil and natural gas), midstream (involved in the transportation, storage as well as processing), and downstream (involved in marketing and distribution of the products). The sector has been under the pump for a few years due to the energy crisis.
The COVID-19 situation has aggravated the condition and added to its woes. Crude oil prices plummeting to historic lows and the impact of the Climate Change Policy triggered massive sell-offs. The 10, 20, and 30-year plans outlining the transition to cleaner forms of energy are weighing on the fossil-fuel industry.
However, according to the latest research report, mentioned on energyworld.com, most of the global energy companies haven’t yet laid concrete plans for climate solution.
The oil & gas stocks saw a massive downtrend in 2020
Investors have been offloading energy stocks amid ongoing fears of an economic recession and slowdown in industrial activities around the world. Further, there is a possibility about a second wave of the dreaded virus impacting countries this winter, making markets jittery.
A broader market uptick in June spurred optimism but selling pressure in the energy sector continued. The widely considered energy sector benchmark, S&P 500 Energy Sector SPDR (AMEX: XLE) has lost over 22% in the past three months. On a year-to-date (YTD) basis, it has plunged nearly 50%. The upstream players have been bearing most of the brunt as compared to the downstream ones.
According to Oilprice.com, the Haynes and Boone Oil Patch Bankruptcy Monitor has revealed that 32 energy companies in the US have filed for bankruptcy protection in 2020 so far. Most of them are in heavy debts and conducting massive layoffs. Only the behemoths with a strong balance sheet like Chevron (NYSE: CVX) or a globally diversified oil-major like ConocoPhillips (NYSE: COP) have been able to weather this storm.
Even as the crude oil prices started to rebound by the end of April, companies in the energy sector are not out of the woods. Historically, an uptick in crude prices leads to a gain in energy stocks. However, we are living in a different phase altogether.
Investors have realized that it is not the energy sector, but the technology sector that is driving the economy. Hence, growth investors are turning to technology stocks to build long-term wealth. A classic example of this is what happened with ExxonMobil (NYSE: XOM).
The Dow Jones Industrial Average which provides weightage according to the price movement of its components had to replace the former energy giant with a tech company, Salesforce.com (NYSE: CRM) as Exxon lost more than 30% of its value over the past decade.
Investors must opt for a cautious approach
That said, the energy sector still remains crucial to the economy. Investing in the energy sector can be rewarding if done strategically, but it has its fair share of risks. It is a cyclical sector and the highly volatile commodity prices fundamentally impact stocks the most.
This implies that investors must not allocate a large portion of their portfolio to energy stocks, especially at this juncture. It is difficult to say whether the sector is on the verge of a correction or is going through a prolonged bear phase. Hence, it is advisable to have a fairly diversified portfolio.
Some of the factors that the investor must consider while choosing energy stocks are the low cost of production, stable revenues, and a cautious approach to dividend payout. Most importantly, the company’s balance sheet should be strong with adequate liquidity and minimal debt exposure.
These are some of the characteristics that will enable the companies to tide over the downturn.
Related: The Healthcare Sector is All Set to See New Highs Amid the COVID-19 Crisis
DISCLOSURE: The views and opinions expressed in this article are those of the contributor, and do not represent the views of Advisorpedia. Readers should not consider statements made by the contributor as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please click here.