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Does The 2020 US Election Mark A Turning Point for Energy Stocks?

As the 2020 election appears to be moving towards a close, what is in store for energy stocks? The industry was up big today, but will that continue. Read more as Andrew Hecht shares his thoughts.

  • The beaten sector offers value
  • Consolidation in the industry will continue
  • Three reasons why oil and gas are not fading into the oblivion
  • Look only to the leaders of the sector- Dividends are a bonus, but not the compelling reason for owning these stocks
  • Buying on price weakness and holding for the long-term

Elections have consequences. After the 2016 election, Democrats in the US heard that from their Republican colleagues. The Democrats will return the favor over the next two years. A close Presidential election went to the Democrats by a razor-thin margin.

Democrats retained control of the House of Representatives but lost a few seats. It appears that Republicans could have a thin majority in the Senate if they can win runoff elections in Georgia in January. However, the Senate is still up for grabs and will be decided in January.

The bottom line from the election is that pollsters got it wrong. There was no blue tidal wave. It took days to count the votes in many states before a winner emerged in the Presidential contest and Senate and House elections. The US remains a nation divided along political lines.

However, the 2020 contest transferred power across the political aisle. Without a blue wave, the legislation will depend on compromise. Many progressive initiatives like the Green New Deal, massive tax and regulatory increases will not have the bipartisan support needed to pass the Senate if it remains in Republican hands.

Moreover, the razor-thin victories could cause Democrats to take a more centrist approach to governing. However, trade, immigration, healthcare issues, and many other initiatives are likely to lean to the left on the political spectrum. The first order of business will be a long-overdue stimulus package.

In November 2016, President Donald J. Trump shocked the world and defeated Hillary Clinton to become the forty-fifth President of the United States. President Trump had been an outspoken advocate of US energy independence and the oil and gas industry. During the month he took the presidency, the S&P 500 Energy Sector SPDR (XLE) was trading around the $70 per share level. The S&P 500 index was below 2200. The price of crude oil was around $45 per barrel on the nearby NYMEX crude oil contract.

President Trump worked to reduce regulations and support energy output, leading US output to rise to over 13 million barrels of crude oil per day when it peaked in March 2020. The US produced more crude oil than Saudi Arabia and Russia, tilting the oil market’s influence away from OPEC, the international oil cartel. Meanwhile, the latest data from the Energy Information Administration as of October 30 said that US daily output stood at 11.1 mbpd, as the US continued to lead the world.

The markets had believed that President Trump would be bullish for the oil and gas industries in the US. The rise in production led to new jobs and lower oil prices. On Election Day, November 3, 2020, the S&P 500 index was above the 3370 level, 1,170 points higher than Election Day in 2016. Crude oil was trading around $38 per barrel, $7 lower than in 2016, and the XLE was below $30 per share, over $40 or more than 57% lower. The Trump Administration’s support for energy production did not prevent price carnage in and gas companies’ shares over his term. The past four years resulted in substantial losses for energy investors.

Republican support for the oil industry did nothing to help investors in the sector, which was counterintuitive.

Democrats support moving the country away from dependence on all fossil fuels, which on the surface is bearish for energy stocks. As we move into a new policy era starting in 2021, we could find that the one-hundred-and-eight percent pivot could have the opposite impact on the energy sector shares in another counterintuitive move over the coming years.

One week later on November 9, after President-elect Joe Biden declared victory, crude oil and oil stocks exploded higher. Pfizer’s (PFE) news that its COVID-19 vaccine is 90% effective ignited a significant rally in the crude oil market and the energy-related shares followed.

The beaten sector offers value

In 2020, the stock market moved to new highs after a coronavirus-led speed bump in March. Technology shares have led the way on the upside. The NASDAQ was up over 32% since the end of 2019 on November 6. The QQQ, which holds the high-flying members of the technology sector, was over 38% higher. While all of the leading indices posted impressive gains, energy stocks remain the stock market’s redheaded stepchildren.

Source: Barchart

As the chart shows, XLE closed 2019 at $60.04 per share. Last Friday, the XLE was below the $29 level, over 51% lower in 2020.

The fund summary and top holdings of the XLE includes:

Source: Yahoo Finance

The XLE has net assets of $8.78 billion, trades an average of over 26.3 million shares each day, and charges a 0.13% expense ratio.

The political shift in the US does not favor fossil fuels, which continues to weigh on energy-related shares. The XLE traded to a low of $23.98 in mid-March, and it was not far above that level on November 6 in the aftermath of the election. On Monday, November 9, the XLE was around 15% higher at over $33 per share.

Consolidation in the industry will continue

Aside from the gloomy outlook for fossil fuels under the new political power base in Washington DC, many oil and gas companies accumulated massive debt levels over the past decade. Historically low interest rates encouraged enormous borrowing. Lower oil and gas prices caused stress when it came to servicing that debt.

Moreover, the evaporation of demand during the pandemic sent prices to the lowest level in history in NYMEX crude oil futures and a twenty-five-year low in natural gas in late June. Only the companies with the most robust balance sheets could survive the conditions that occurred over the past year.

As many smaller companies fall by the wayside, assets will be on sale for pennies on the dollar. In an example of how value investors are looking to scoop up energy assets, Warren Buffett’s Berkshire Hathaway purchased transmission and pipeline assets from Dominion Energy (D) in early July for $10 billion in cash and acquired debt. The announcement of the deal that expanded Berkshire’s control of US interstate transmission assets from 8% to 18% came only days after natural gas fell to the lowest price since 1995.

We are likely to see lots of consolidation, acquisitions, and some bankruptcies in the energy sector over the coming months. However, the leading companies will survive. Those ready to adapt to changes in the regulatory environment and with the ability to purchase undervalued assets could thrive in the coming years.

Three reasons why oil and gas are not fading into the oblivion

Oil and gas are still hydrocarbons that power a growing world. While Democrats will tighten the regulatory noose on the industry compared to the Trump administration, the US and world requirements for crude oil products and natural gas will not decline in the foreseeable future. The first reason is that the global addiction to fossil fuels is a habit that will not change over the coming decade.

While it may decline, the population continues to grow at a rate of around twenty million per quarter. At that rate, there would be 8.5 billion people on the earth in 2030 compared to 7.7 today. Energy demand is increasing, and while alternative sources are required to keep pace with needs, oil and gas will continue to play a role in powering the world.

The second reason why oil and gas will continue to play a prominent role in the world is that the US is not the only factor in the international energy markets. US policy may change, but the Middle East and Russia will continue to produce the energy commodities. Moreover, the world’s most populous nations, China and India, will continue to be consumers with their requirements growing over the coming years. If US energy policy shifts too dramatically too quickly, it would simply hand the influence back to OPEC and Russia, causing prices to soar.

Finally, the odds favor higher commodity prices over the coming months and years. A falling dollar is bullish for the price of crude oil, as it is the global pricing mechanism. The dollar has been falling since March and was approaching the recent low at the end of last week. Central bank liquidity and government stimulus increase the money supply, which supports inflationary pressures. Commodity prices rise as inflation erodes currency values, and crude oil is no exception.

Higher oil prices over the coming years would support a rebound in the shares of the leading oil companies. Moreover, if they pick up inexpensive assets during the current industry-wide consolidation period, we could see the share prices soar from the current levels.

The vaccine news on November 9, and the reaction by crude oil and energy shares was a sign that the path of least resistance of prices could be shifting to the upside.

Look only to the leaders of the sector- Dividends are a bonus, but not the compelling reason for owning these stocks

Exxon Mobile (XOM) has been under siege in 2020. In August, the DJIA replaced it with Salesforce (CRM). While the company posted a loss over the past two quarters, it beat analyst projections by seven cents in the third quarter. The company did not increase its dividend for the first time in a decade.

However, XOM continues to pay shareholders $3.48. At $32.78 on November 6, the yield was at over 10.6%. On November 9, XOM was trading at the $37.15 level, up over 13% from the November 6 close.

Chevron Corporation (CVX) has less debt than XOM, and the company reported a small eleven cents per share profit in Q3, which beat analyst estimates by 38 cents. CVX pays its shareholders a $5.16 dividend, which equates to around 7.25% at a share price of $71.15 on November 6. On November 9, CVX rallied to the $80 per share level, up over 12% from the end of last week.

The dividends are attractive but are not the reasons to own XOM and CVX. The companies could suspend or end the payments over the coming months if economic conditions decline during the second wave of the coronavirus. In the US, Exxon and Chevron are the only two companies I would consider. In Europe, British Petroleum (BP), Royal Dutch Shell (RDS-B), and Total (TOT) are candidates for investment because of their strategic importance to the continent. In many ways, the five companies’ survival is a matter of national security for the US and Europe. All of those stocks experienced double-digit percentage gains on November 9.

Buying on price weakness and holding for the long-term

I would be a buyer of the oil companies at the current levels, leaving plenty of room to add to long positions on price weakness. While I will not count on dividends, they provide a bonus for as long as the companies continue to pay.

It is impossible to pick bottoms in any market. However, I am willing to bet that XOM, CVX, BP, RDS-B, and TOT will remain viable companies over the coming years. Moreover, the depressed values make the potential for substantial rallies a possibility. Oil is not going away as an energy source for the world any time soon. The US election may have dealt the energy commodity a psychological blow but remember that the share prices tanked with the Trump Administration’s support. Perhaps a hostile administration is necessary for a recovery. The rally in the sector on November 9 could turn out to be a watershed event for energy.

Meanwhile, the economic landscape is ripe for inflationary pressures over the coming years. Crude oil prices should move higher with a falling dollar and rising inflation. Higher crude oil would increase earnings, allow for a continuation of dividends, and translate into higher share prices in a stock market where locating value is more than a challenge.

The worst performing sector over one period often becomes the best during the next period. Since 2018, oil-related shares had been falling. Things always look darkest before the dawn. The election results, at face value, make energy stocks look even worse. I favor a contrarian approach and will hold my nose and buy the leading companies on any price weakness over the coming weeks and months. November 9 may be the day that the energy sector finally turned.

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XLE shares rose $0.04 (+0.12%) in after-hours trading Monday. Year-to-date, XLE has declined -42.04%, versus a 11.74% rise in the benchmark S&P 500 index during the same period.



About the Author: Andrew Hecht

Andy spent nearly 35 years on Wall Street and is a sought-after commodity and futures trader, an options expert and analyst. In addition to working with StockNews, he is a top ranked author on Seeking Alpha. Learn more about Andy’s background, along with links to his most recent articles.

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