Despite the recent sell-offs in oil, investors are warming up to the energy sector, which bore the brunt of last year’s shock of crashing oil prices and oil demand. The energy sector has been the top performer in the S&P 500 index year to date, despite the price routs last week and earlier this week. Some exchange-traded funds (EFTs) tracking oil prices have surged since the start of 2021 as investors turned their attention to industries expected to benefit the most from the economic recovery. Energy is one of those, and analysts still see upsides for energy stocks and ETFs.
Debt investors are also more bullish on the oil sector as higher oil prices lifted the yields of existing high-yield bonds of lower-rated companies in the sector. Investor appetite for high-yield bonds of low-rated U.S. energy firms is back, while the American shale patch is enjoying what is believed to be the best opportunity to borrow at record-low interest rates since oil prices traded above $100 a barrel back in the first half of 2014.
U.S. consumer sentiment rose in early March 2021 to its highest level in a year thanks to the progress in vaccinations and the coronavirus relief bill, according to the latest survey of consumers of the University of Michigan. Moreover, travel statistics show that U.S. consumers are driving and flying this month at the highest rate since the pandemic forced the United States into stay-at-home orders and lockdowns in March last year.
Despite persistent concerns about near-term oil demand in Europe, expectations of economic recovery—especially in the world’s largest economy, the United States—have boosted investor confidence in the oil sector.
Energy Sector Top Performer Of 2021
Year to date to March 23, energy outperformed—by a country mile—all other sectors in the S&P 500, including the index itself, data compiled by Yardeni Research shows. Even after the recent price collapses that saw Brent pull back from as high as $70 to $60 a barrel in two weeks, the energy sector has gained 26.3 percent year to date, compared to a 4.1-percent rise of the S&P 500. The second-best performing sector, financials, has gained ‘only’ 12.4 percent.
Oil ETFs have also rallied this year. ProShares Ultra Bloomberg Crude Oil ETF (NYSEARCA: UCO) has surged by 45 percent year to date to March 23, while the United States Oil Fund LP (NYSEARCA: USO) has jumped by 21.6 percent.
Most of those gains are attributed to the rising oil price this year and to hopes that economies re-opening will boost overall energy and oil demand later in 2021, after the oil sector was excessively punished by the 2020 crash and crisis.
The brighter prospects for oil demand have also led to the recovery of the high-yield bonds that companies have issued.
“It’s the oil-linked names in high yield that have been among the best performers recently,” John Dixon, a high-yield bond trader at Dinosaur Financial Group, told the Financial Times.
A better energy environment has allowed refinancing for several high-yield issuers in the U.S. energy sector, Fitch Ratings said earlier this month, when Brent was trading at around $65 a barrel. If capital markets remain open and crude oil prices remain intact, the sector’s high-yield default rate could decline to 4 percent or lower. Last year, the sector accounted for 41 percent of the high-yield defaults, but that percentage this year should be closer to 20 percent, according to Fitch.
Record High-Yield Bond Issues
The returning investor appetite for high-yield bonds of low-rated U.S. energy firms has helped them to raise a record more than US$20 billion on the bond market so far this year, according to data from companies tracked by Refinitiv and cited by the Financial Times.
Historically low interest rates also give additional incentives to the U.S. shale patch to raise new debt to refinance existing liabilities. Currently, it’s as cheap for the U.S. energy sector to raise new debt as it was seven years ago, when oil was $100 per barrel, according to Bloomberg Intelligence, which expects this quarter to become the busiest for low-rated debt raised in at least five years.
“Many may not be able to resist the siren song of historically low interest rates,” Bloomberg Intelligence analyst Spencer Cutter wrote in a report this week.
Investors Still Skeptical On Oil In The Energy Transition
While investors have evidently warmed up to the short-term and, to some extent, the medium-term prospects for the oil and gas industry, the jury is still out whether the recent race to net-zero pledges from Big Oil would attract investors in the sector longer term. BP’s chief executive Bernard Looney said last month that investors were still coming to grips with the net-zero and green shift strategies of the major oil companies. The Environmental, Social, and Governance (ESG) investing trend is a force to be reckoned with in the future of the oil industry. Companies that consistently reward shareholders and at the same time show decent returns in low-carbon investments could win investors over even in the long term.