Energy Ended Up as a Good Bet Last Year. But Now What?

Energy companies defied the odds last year.

Despite a pandemic and pressure to phase out fossil fuels to combat global warming, the share prices of major energy companies outshone the rest of the S&P 500.

Oil and natural gas prices, which soared 59 percent, were the main impetus for the energy stock rally.

But the boom wasn’t a steady one. Although energy stocks in the S&P 500 rose around 50 percent, it was an up-and-down year.

“The ride getting there has been extreme,” said Liz Ann Sonders, the chief investment strategist at Charles Schwab. She cautioned investors thinking of jumping in now to “be mindful of the peril of chasing sector performance based on what it has done in the past year.”

In 2021, oil prices rebounded from a decline in 2020, rising in response to growing demand as the coronavirus pandemic appeared to be ebbing. That helped drive inflation, and consumers grumbled about higher prices at the pump.

In November, President Biden led a multilateral effort — which included Britain, Japan, South Korea, India and China — to release oil from national reserves. OPEC Plus, a group of oil-producing nations, agreed to increase supply gradually. Adding to uncertainty about the oil prices are the still unclear effects of the Omicron variant of the Covid-19 virus on the economic recovery. Longer term, there are major questions about how the world might make the transition to cleaner forms of energy like solar and wind power from oil, coal and natural gas.

David Lebovitz, a global market strategist at J.P. Morgan Asset Management, said the large integrated oil and natural gas producers are working on developing renewable energy technologies in a bid to stay relevant. “They have one foot on either side of the energy line,” he said, “so it’s a way for investors to play both sides of the story if they don’t want to make a commitment.”

Funds that invest in the energy industry tend to be dominated by these global companies. For example, the Energy Select Sector SPDR, an exchange-traded fund with $26.4 billion in assets run by State Street Global Advisors, had total returns of 53.26 percent in 2021 after a management fee of 0.12 percent. Forty-four percent of the portfolio is invested in two companies, Exxon Mobil and Chevron.

Michael Jin, a senior equity research analyst at Epoch Investment Partners, a New York subsidiary of Toronto-Dominion Bank, says U.S. utility companies are beginning to embrace solar and wind turbines. “We kind of tiptoed into investing in renewable energy through the utilities sector,” he said. “It’s a good way to gain exposure, because these fee-based companies are more like toll roads. They are still able to generate cash flow and pay dividends.”

Utility funds, traditionally viewed as generators of steady income because of their holdings in regulated public utilities, posted strong returns last year. The Vanguard Utilities exchange-traded fund, with $5.6 billion in assets, returned 17.33 percent in 2021 after the 0.1 percent management fee. The fund’s yield was 2.7 percent.

The $4.9 billion Vanguard Energy fund, which once held mainly energy companies, has directed half its assets to holdings of utility companies since late 2020. Last year, the fund had total returns of 27.71 percent after a management fee of 0.33 percent. Its yield was 3.63 percent, according to Morningstar Direct.

How much demand there will be for oil in the coming decades remains a crucial issue for energy investors. A recent Morningstar report forecasts that global oil demand will peak around 2030 and then gradually decline. By the middle of this century, the report estimates, the global economy will consume 11 percent less oil than it did in 2019, in large part based on the projection that more than half the traffic on the world’s roadways will be electric vehicles.

“We’re bullish on the adoption of electric vehicles,” said Dave Meats, the director of research for energy and utilities at Morningstar. In part, he said, that is because China has been subsidizing the development of electric vehicle technology in the hope of dominating this global market in the future.

But he predicted that oil would continue to be needed for global shipping and air travel in 2050. The weight of the batteries needed to cover long distances could be too much to keep ships afloat and planes aloft. He added that jet biofuel from sources like corn or used cooking oil would probably be more expensive than traditional fuel.

Oil may not be the fuel of the future, but oil consumption won’t vanish overnight. Unlikely as it may seem, it’s possible that energy companies can continue defying the odds for some time.