Energy sector stocks: Is now the time to invest?

Although energy prices in 2024 have been relatively stable, energy stocks, typically one of the more volatile sectors of the equity market, enjoyed a solid recovery during this year’s opening months. In 2023, the S&P 500 energy sector vastly underperformed the broader stock market as measured by the S&P 500 (-1.33% for energy versus +26.29% for the S&P 500). Investors are showing increased interest in the energy sector in 2024. Through April 23, energy stocks gained 15.81% compared to 6.76% for the S&P 500 broadly.¹

How energy stocks respond to price trends

Since energy prices peaked in 2022, they’ve declined significantly. Energy prices often tend to drive the direction of energy stocks. The energy sector stock surge of 2021 and 2022 came at a time when oil prices trended much higher, peaking at more than $120/barrel in 2022. But in 2023, oil prices were flat to lower,² and energy stocks followed suit. Today, prices for various energy products are down significantly from 2022 peaks, though energy stocks have performed well in 2024 so far.

All prices published by U.S. Energy Information Administration. Crude Oil Prices: West Texas Intermediate (WTI) – Cushing, Oklahoma as of March 31, 2024. Gasoline: U.S. Regular All Formulations as of April 22, 2024. Natural Gas: Henry Hub Natural Gas Spot Price as of March 31, 2024. Heating Oil: No. 2 Heating Oil Prices: New York Harbor as of April 15, 2024.

What do prospects for the energy sector look like in 2024 and beyond? How should investors view opportunities in this specialized segment of the market representing a critical part of the global economy?

Energy’s shifting profile in the stock market

During the Arab oil embargo and various Middle East conflicts of the 1970s, the energy sector represented approximately 15% of the broader U.S. stock market. Today, it makes up less than 4% of the S&P 500 index.¹ “Those numbers might suggest that it is an industry in decline, but energy consumption is up since the 1970s, and the important role energy plays in the broader economy is not diminished,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “From an earnings (profit) perspective, energy stocks play a more prominent role in today's S&P 500 than their index weighting would indicate.”

World oil consumption continues to trend higher with the notable exception of a decline in 2020 as world economies slowed due to the COVID-19 crisis.³

While energy stock performance is somewhat tied to the direction of oil prices, Haworth points out that oil refiners and storage and transportation company earnings are not directly tied to the direction of oil prices. Haworth also points out that about one-third of the S&P 500’s energy sector is composed of natural gas companies, a market where pricing generally moves independently from oil price trends.

The slow transition in the energy sector

Renewable energy sources, particularly wind and solar, are slowly gaining a foothold in world energy production, but the role of renewables today is dwarfed by other sources such as fossil fuels and nuclear, which combined makeup nearly 79% of all energy production in the U.S., while about 21% comes from renewable sources (including wind, solar and hydroelectric power), little changed from its role in the prior year.⁴

On a worldwide basis, renewables represent less than 15% of all electricity production.⁵ “Alternatives like wind and solar are not a factor in the S&P 500 Energy Index to this point,” says Haworth. “In some cases, they may be represented in other sectors of the market, such as utilities or information technology.”

Efforts are also underway to reduce greenhouse gas emissions by converting fossil fuel-driven automobiles to electric vehicles (EVs), but it is a slow transition. In February 2024, EVs accounted for only 6.5% of U.S. new car sales.⁶ However, EVs are experiencing faster growth abroad. More than 20% of cars sold worldwide in 2024 are expected to be electric.⁷

Recent trends put more pressure on oil stocks

Declining oil prices contributed to the energy sector’s underperformance in 2023. A barrel of crude oil was priced in the $80 range at the start of 2023, down considerably from 2022’s peak price of more than $120/barrel. By January 2024, the price hovered near $70/barrel.² Prices moved above $80/barrel in mid-March 2024 and stayed near that level.

Speculation arose that energy prices could rebound in the wake of rising tensions in the middle east stemming from the surprise Hamas attack on Israel in October 2023 and Israel’s response with military crackdown on the Gaza Strip. Concerns of a more widespread conflict persist, but have yet to be realized. “We saw a modest spike in prices when Israel retaliated after the Hamas attack,” says Haworth. “However, oil production has not generally been affected by events in the Middle East.” In addition, the U.S. is more insulated from oil shocks as it has moved from a net importer to net exporter of oil.⁸

Investment considerations in today’s energy market

Investments in the energy sector today are primarily directed toward more traditional companies that participate in industries like oil and natural gas. While the price of resources such as oil and gas can have an impact on company results and stock performance, “the demand for fossil fuels is not going away in the near term,” says Haworth. He emphasizes that opportunities can be found even in a market featuring more stable prices. “Many exploration and production companies have productive oil wells and should be able to generate solid profit margins,” says Haworth. “Since these companies tend to return capital to shareholders in the form of dividend payouts, their stocks represent an opportunity for income-orientated investors.”

Other opportunities can be found in what’s referred to as the midstream energy sector, involved in the transportation of crude oil or refined petroleum products. “This sector is less dependent on energy prices than on the flow of oil, and volume moving through these facilities remains high,” says Haworth. Midstream companies tend to pay attractive dividends. However, the investment process can be more complex as it sometimes requires investments in limited partnerships. They require issuance of K-1 forms to investors for tax reporting purposes, which can complicate an investor's tax filing process.

Alternative investments, such as renewables like wind and solar, are less visible in the investment markets. Utility companies emphasizing renewable energy sources offer one opportunity to pursue this part of the market. Some manufacturers of wind or solar equipment also offer opportunities, but they are far more limited than more established, traditional energy companies.

Energy stocks will play a modest role for those who invest in an index fund or ETF replicating the S&P 500 Index. Beyond that, consider consulting with your financial professional to determine whether more targeted investments in the energy sector can help you meet your long-term financial goals.