Energy is a common enough commodity, but investing in energy and related exchange traded funds (ETFs) requires a little finesse. Despite being one of the most profitable sectors in the last decade, the energy sector has had a challenging couple of years.
What Is the Energy Sector?
The word energy encompasses a broad range of things relating to the sector. The sector includes oil and gas exploration companies, energy retailers, electric utilities, alternative energy. Then there’s nuclear, coal, natural gas and more.
Energy and fossil fuel powers daily life, particularly in developed economies. Gas runs our cars, natural gas helps us heat our homes and cook our food, even the sun and wind provide energy that utilities are increasingly looking to harness.
But energy is a sector that faces challenges.
A number of factors have hit the sector in recent years: an oil price bubble that burst, the BP oil spill, a ban on offshore drilling and the possibility of new taxes and restrictions on investing in the sector have all had an impact on both prices and public perception.
Energy is also one of the more volatile subsets of commodity investing. In general, commodities can move quickly and what was hot this month may not be next month. This has become especially true in recent years. Among the events and occurrences that can send shock waves through the energy markets and send prices soaring include:
- Political events. This often refers to pipeline bombings, which aren’t unusual in the Middle East and Africa, in particular.
- Weather. A strong hurricane is enough to send natural gas prices soaring because there are a number of natural gas rigs in the Gulf of Mexico. A period of intense heat or cold can also push demand for energy higher.
- Supply and demand. If consumers aren’t using enough oil and a glut forms, prices will fall. If consumers increase demand and it leads to a shortage, prices rise.
- The dollar. Oil and many other commodities are priced in U.S. dollars. When the dollar becomes weaker, oil becomes cheaper for investors overseas, which helps drive demand.
The bottom line is that when it comes to oil prices, it’s important to anticipate some volatility and take extra steps to protect your clients’ portfolios with some kind of exit plan, if using one becomes necessary.