Some FAQs on 2021’s Top-Returning Sector to Date: Energy

Three weeks shy of 2021’s half birthday, Energy is still the MSCI World Index’s top-performing sector year to date. Its 35.6% return through Monday’s close is beating global stocks’ 12.4% by a country mile as investors continue rewarding oil prices’ rise.^[i] We have written before of our belief that this phenomenon will probably prove temporary, and our opinion hasn’t changed. But setting all that aside, this seems like a good time to answer a couple of frequently asked questions about the sector.

1. Why isn’t Energy having a bigger impact on global returns? Should I own more to get some extra oomph?

The answer to the first half of this two-parter explains why the answer to the second is “no”: Energy is only 3.25% of global market capitalization as of Monday’s close.^[ii] That is down from 10.17% on Halloween 2007, the day global stocks peaked ahead of 2007 – 2009’s financial crisis. Not coincidentally, even with this year’s rally, global Energy stocks are still down -16.3% since then.^[iii] The shale boom may have lifted US oil output to generational highs and added big economic tailwinds for oil-rich regions in the 2010s, but it tanked oil prices, which hit Energy companies’ earnings hard worldwide. That hammered returns and the sector’s global market clout. Last year made it even worse when the pandemic wrecked demand for jet fuel, gasoline and other oil-intensive goods and services. So what we are seeing now is a fledgling rebound off of a very, very low base.

Now, irrespective of past performance and our outlook, we do think it makes sense for investors to own some Energy stocks. That is what diversification is all about—having exposure to areas of the market whether or not you expect them to do well, just in case you are wrong. But use its weighting in global markets as a guide. If your personal weighting to Energy is a lot higher than global markets’, you are taking a lot of risk and may be sorely disappointed if your overweight lags badly from here and you have less exposure to the categories that do better.

2. Why do you guys always bang on about oil when you write about Energy? Aren’t renewables the future and a big reason the sector is leading?

Well, the jury is out on whether wind and solar are the future or if that honor will go to hydrogen, next-gen nuclear or some other cool thing. But it doesn’t have much to do with Energy stocks, because those newfangled renewables aren’t in the Energy sector—they are all hanging out in Utilities, which happens to be the worst-performing sector year to date, up a paltry 2.9%.^[iv]

We get it, this is weird. But it is all about the industry classifications. Energy has two industries: Energy Equipment & Services, which has your standard oil drilling equipment makers and transporters, and Oil, Gas & Consumable Fuels, home to all of your favorite fossil fuel producers. Those categories have no place for solar panel manufacturers, turbine makers or wind farmers. But if you look at Utilities’ industries, you will see the aptly named Independent Power & Renewable Electricity Producers. A lot of your green renewable friends live there, while the remainder are in Electric Utilities or Multi-Utilities. But even then, the impact is still limited. Independent Power & Renewable Electricity Producers is just 0.25% of MSCI World Index market cap.^[v] The smattering of companies that dabble in wind and solar are a tiny share of the other two industries.

Of course, some fossil fuel firms have alternative energy divisions, but they are generally a pretty small fraction of the overall firm. The same goes for the handful of Industrial Conglomerates that offer exposure. The scope in these areas is quite limited.

It is a matter of some debate whether these categorizations make sense, and the sector arbiters may eventually decide they don’t. Just as they split some giant Tech companies into Consumer Discretionary and Communication Services a while back, they may eventually merge Energy and Utilities. Or move the renewables out of Utilities and into the mother ship. But that is all just a possibility and not a probability. So for the time being, when we discuss the Energy sector, know that we are basically discussing oil—and that isn’t our choice, but the index providers’.