Are Energy Stocks an Opportunity or a Value Trap?

By David Lebovitz via

The S&P 500 energy sector has lagged the strong performance of the broader index, falling by over 6% so far this year. Energy remains unloved for a number of reasons – value investors don’t think it is cheap enough, and growth investors don’t see the future upside – but we believe that there is good reason to be optimistic that better times may lie ahead.

First, global oil markets have come into balance. When investors talk about commodities, they often highlight whether the “curves” are in backwardation or contango – in other words, whether today’s prices are higher (backwardation) or lower (contango) than future months.

Curves in contango suggest that oil is oversupplied, as current months trade at a discount to future months; until recently, oil markets have been in contango for the better part of the past three years. However, as the global oil supply/demand dynamic has gradually come back into balance, current prices have risen above future prices, reflecting a tightening in oil supplies.

Importantly, and as shown in the chart below, there is a significant relationship between the slope of the commodities curve and the performance of energy stocks. With the slope of the curve back in positive territory and steepening, energy stocks could be set to outperform.

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