The energy sector was one of the worst-performing groups in the S&P 500 in 2018, as highlighted by an annual decline of 18.20% for the Energy Select Sector SPDR (NYSEArca: XLE), the largest equity-based energy exchange traded fund.
Some market observers believe the energy sector’s declines could make the sector more attractive on valuation. Last month, the energy sector experienced a short-lived rally after lengthy Organization of the Petroleum Exporting Countries (OPEC) discussions finally came to a conclusion, resulting in a larger-than-expected production cut that sent oil prices higher.
Predictably, plunging oil prices plagued energy equities late in 2018.
“The more than 30% drop in oil prices from the 2018 peak has coincided with a period of weakness for broader equity markets, making energy stocks look much more attractive than they did when OPEC met in June,” said Morningstar in a recent note. “The median price/fair value in our global energy coverage is 0.77. Roughly 8% of our energy coverage trades in 5-star territory, among the higher shares at a sector level.”
OPEC Looms Large
With oil prices needing positive catalysts, the ability of OPEC to lower output is critical for the commodity’s near-term fortunes. Likewise, some market observers are concerned about U.S. shale producers keeping output high as prices decline.
“We said in June that a shale-induced supply surge would be the likely catalyst to sink oil prices toward our midcycle price,” said Morningstar. “This has largely played out, with U.S. production up 7.5% from June to September and more than 14% since the end of 2017. Other factors have contributed to the oil price decline since the last OPEC meeting, including higher-than-expected Iran production and demand worries as prices rose.”
Morningstar likes some midstream and refining names, but is bullish on some other corners of the energy patch, as well.
“Nonetheless, the recent sell-off has created buying opportunities for multiple integrateds, exploration and production companies, and services firms, too,” according to the research firm.
Rivals to XLE include the Vanguard Energy ETF (NYSEArca: VDE), iShares U.S. Energy ETF (NYSEArca: IYE) and the Fidelity MSCI Energy Index ETF (NYSEArca: FENY).
For more information on the oil market, visit our energy category.