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There are a number of reasons why it makes sense to be bullish on energy stocks going forward and to add exposure on any meaningful pullbacks. This sector has been in an uptrend, and while it might be overbought and due for a pullback, the bull run could continue for many years.
Energy Select Sector SPDR Fund ETF (NYSEARCA:XLE) is a very liquid and popular way to get energy exposure. It has heavy weightings in Exxon Mobil (XOM) which is nearly 23% of assets. Chevron (CVX) weighs in at just over 17% of assets. ConocoPhillips (COP) is around 9% of assets and from there the weightings are smaller with names like EOG Resources (EOG), Marathon Petroleum (MPC), Schlumberger (SLB) and more. This fund yields over 3% and the overall average price to earnings ratio for it is just over 11, making it something value investors could love.
The Chart
As the chart below shows, this fund has been in rally mode, and there is good reason to believe more gains are coming in the long-run. However, I would wait for pullbacks before buying more or starting a new position. The 50-day moving average is near $85 and the 200-day moving average is close to $84. This indicates a very bullish “Golden Cross” has formed on the chart. If we see a pullback to the $85 level, I believe that would be an ideal time to buy.
StockCharts.com
#1 The Fed Is Going To Ease
Jerome Powell just gave us an update on his policy views and he laid out plans for three interest rate cuts in 2024. The Federal Reserve is expected to start easing this year and possibly continue easing until 2026. This helps set the stage for a weaker U.S. Dollar which is bullish for oil. The market is already starting to price this easing in, and this can be seen by the recent rise in gold and oil prices which tend to move in tandem, as the Dollar weakens. One analyst at Carlyle Group, said the upside for oil is significant, as soon as the Fed starts cutting rates.
#2 The U.S. Strategic Petroleum Reserve “SPR”
The SPR was drained by the Biden Administration after the invasion of Ukraine. This was an attempt to push prices down as concerns mounted over global energy supplies, and it was the largest SPR sale ever made. But now it’s time to pay the piper, and the Biden Administration said it seeks to refill 180 million barrels of oil by the end of 2024. This need to refill the SPR could help keep any oil pullbacks as being brief and shallow.
#3 China Demand Could Improve
China is a huge consumer of oil and as most investors know, the Chinese economy has not experienced the rebound that many expected after the Covid lockdowns ended. China was growing at a very fast clip prior to Covid, but it seems that the country has decided to make a number of choices, (such as a pursuit of Taiwan), that have brought up global concerns about China as a supply chain leader. This rethink has motivated many CEOs to consider sourcing from countries like India and Mexico, as well as onshoring. This and a real estate crisis in China has dampened growth rates significantly. However, the Chinese Government seems to be taking notice, and it has recently announced new efforts to stimulate the economy and reassure Western business leaders. If these results are successful, Chinese demand for oil could raise prices in the coming years. China is the world’s second largest consumer of oil and it uses nearly 13 million barrels of oil each day. About half of this oil is imported so any incremental demand from China could significantly boost oil prices.
#4 Global Population Growth
The global population is growing, and that means more energy consumption. On top of this, many countries are expected to see huge growth in middle class populations which means big potential increases in energy demand. A recent CNBC article points out the bullish case for energy demand in the long-term by stating:
“The world population is going to increase by about 25% between now and 2050, but energy demand will increase faster than that,” Shaikh Nawaf al-Sabah told the CERAWeek by S&P Global energy conference in response to a question about whether demand will peak by 2030.
“That means that we’re going to require more energy intensity for the population in the world,” al-Sabah said. Three-quarters of a billion people in the developing world have no electricity and nearly 2.5 billion people have no clean cooking solutions, according to the CEO.
#5 AI Could Significantly Boost Energy Demand
AI is expected to create significant new demand for energy in the coming years. With many AI stocks trading for price to earnings multiples of 40 times or more, energy stocks could be an undervalued way to participate in the growth of AI. An article by Scientific American analyzes some of the estimates for AI-related energy usage and it points out that under some scenarios, Google’s (GOOGL) search engine alone could use up as much power as the country of Ireland. It also goes on to state:
A continuation of the current trends in AI capacity and adoption are set to lead to NVIDIA shipping 1.5 million AI server units per year by 2027. These 1.5 million servers, running at full capacity, would consume at least 85.4 terawatt-hours of electricity annually—more than what many small countries use in a year, according to the new assessment.
A Few Other Bullish Factors
U.S. driving season is coming up, and it typically starts around Memorial Day Weekend, which is on May 27, 2024 and continues through Summer. This is a period of increased energy demand because of road trips, and also because of the need for air conditioning with hot weather in many states. This is a high demand period for energy and it usually results in higher prices.
There are also ongoing geopolitical issues that could significantly raise oil prices in the coming months and years, and of course new risks could pop up at any time. The current issue with ships not being able to pass through the Red Sea safely could get worse, and other hot spots in the world could lead to supply disruptions. Some analysts predict a 20% increase in the price of oil, if the Middle East conflict disrupts the Strait of Hormuz.
What I Don’t Like About Energy (Potential Downside Risks)
Right now I don’t like that the energy sectors (and the market as a whole) are in overbought territory. This could lead to some pullbacks, which could be better buying opportunities. The energy sector is highly regulated and politicized, and it is also prone to lawsuits. Oil is a commodity and therefore it can be volatile and have boom and bust cycles. As such, a global recession would likely cause a major drop in oil prices and this could lead to an even bigger selloff in energy stocks.
In Summary
There are so many factors that could cause energy prices to rise in the short-term and even more so in the long-run. I would use pullbacks to add to positions or start new positions. I think the Energy Select Sector SPDR Fund ETF is a great way to invest in energy, as it gives you diversification and a solid dividend.
No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.
