The iShares U.S. Energy ETF (NYSEArca: IYE) is among the energy sector exchange traded funds rallying this year. IYE is up more than 10% on the year, but double-digit gains across the energy ETF landscape does not mean the once downtrodden sector is lacking value.
In fact, by some estimates, the energy sector remains cheap. Some market observers believe the energy sector’s 2018 declines could make the sector more attractive on valuation. Last year, 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.
“The energy sector closed January at 1.7 times price-to-book (P/B) value. While this is roughly 10% above December’s multi-decade low, current valuations are still below the depressed levels witnessed in November and in the bottom 10% of historical observations,” according to BlackRock.
What’s Next
January 2019 represents one of oil’s best monthly performances on record. The month was Brent crude’s best month since April 2016. Energy information provider Argus Media, said producer cuts will eventually help level oil prices again as 2019 wears on.
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.
“On a relative basis U.S. energy companies continue to trade at the largest discount to the broader market since at least 1995. The P/B on the sector is about 50% of the broader market’s,” notes BlackRock.
How the U.S. dollar behaves throughout 2019 will be meaningful for energy sector valuations and the group’s performance.
“Since 1995, the relative P/B of the energy sector has been approximately 10% higher when the Dollar Index (DXY) is lower year-over-year versus times when the dollar is higher,” according to BlackRock. “This relationship is arguably a function of several factors. A weaker dollar is supportive of commodity prices, which are generally denominated in dollars, as well as representing a de facto monetary easing.”
For more information on the oil market, visit our energy category.