There’s a big chain coffee shop near me that I have basically written off. Every time I walk into it, I am disappointed. Disappointed that despite how many people are working there, my medium coffee takes 20 minutes or more to be poured — especially when I seem to be the only patron. So instead, I go to the smaller shop around the corner that’s always friendly and quick, even when it’s crowded — which is often. At this point, it would take quite a bit to get me to change my mind and go back to the big shop.

I was thinking about how this very thing happens in the markets, too. The energy sector has had quite a roller coaster over the past 20 years. Not just from the ups and downs of oil and gas prices, but also from the way certain types of energy companies funded themselves and factored in expectations of future supply/demand. All of it led to investors writing off the sector for quite some time, influencing the way companies in the sector now behave.

Let’s start with a data point to help. 

Here are US oil prices over the last 20 years (October 2002 to October 2022):

From 2002, you can see oil prices rallied for several years, dropped in 2008, and then mostly recovered, trading around $100 from 2011 to 2014. During this four-year period, oil companies invested heavily in their own businesses to produce as much oil as possible, given the consistently higher prices. They didn’t care as much about costs and assumed demand would stay elevated indefinitely.

Yet in 2014, oil prices dropped suddenly and settled at around $50 for the next five years. The whole energy sector went through its own recession. Companies in the sector cut costs, closed rigs, and tried to stay afloat. Then the pandemic hit and demand crumbled. At the same time, OPEC saw an opportunity to take market share, keeping supply levels up, seemingly to destabilize US competitors.

Fast forward to today and the energy companies — especially the ones most exposed to the price of oil as opposed to the larger diversified energy companies —  seem to be a little more cautious. They are not aggressively expanding production to ensure profitability. Can you blame them? 

Equally, investors also seem to be cautious about the sector. In the calendar years from 2014 through 2020, the S&P Energy sector had negative returns in five years out of the seven-year stretch. So, the energy sector was slowly written off by many after 2014. Can you blame them? As a result, the energy sector got smaller and smaller in the S&P 500. In 2014, the Energy sector had a 7% weight in the S&P 500 Index, which fell to 3% in 2021. 

This leads me back to the beginning. Like me and the big coffee shop, I believe investors have been slow to come back to the energy sector. They had been disappointed by it for so long. At the same time, energy companies, after being forced to be more frugal with spending and focus on profits, are not jumping back to their old selves — actually making them potentially relatively more attractive than in years past.

Time heals all wounds. Earnings posted from the sector beat expectations that have been slowly moving higher. And while these companies are often subject to the swings of oil and gas prices, they have gotten more astute at managing these risks — which can be seen in the control of capital expenditures and production and hedging oil price risk. Meanwhile, the Russia-Ukraine conflict, production cuts by OPEC*, as well as political constraints to expanding oil production in the U.S. have contributed to higher oil prices and keep them potentially tilted towards the upside. 

To me, the sector continues to look attractive, although it’s not without its risks. Year-to-date, the energy sector is up nearly 70% through November 1. So some of this is already reflected in stock prices. Of course, all of this excludes the impact of oil and gas on this green earth. 

In reality, higher oil prices come at a time when it would be nice for us consumers to get more supply to help lower prices right now. But these companies have different philosophies than they may have had in the past, because they will also likely be slower to change, for fear of producing more right before demand slows again.

Waiting and watching, perhaps there will be a time soon when both sides decide they’ll test it out in greater numbers again.

*OPEC = Organization of the Petroleum Exporting Countries, currently consisting of 13 member countries with a substantial net export of crude petroleum.

Sources: US EIA. S&P Global.

First chart: U.S. Energy Information Administration, Crude Oil Prices: West Texas Intermediate (WTI) - Cushing, Oklahoma [DCOILWTICO], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DCOILWTICO, October 30, 2022.