The Energy Select Sector SPDR (NYSEArca: XLE), the largest equity-based energy exchange traded fund, is off about 8% over the past week as U.S. stocks have tumbled, but that could represent a buying in the once downtrodden energy sector.
Supporting the crude oil markets, the expanding global economy has increased demand for commodities and drawn down oil inventories. For instance, according to the Energy Information Administration, U.S. crude stockpiles have declined for the past 10 consecutive weeks and are now at their lowest level since 2015. Recently, Exxon Mobil (NYSE: XOM), the largest U.S. oil company, said it plans to triple investments in the Permian Basin by 2025.
Meanwhile, the energy industry has grown more efficient after cutting costs in response to the plunge in crude oil prices in previous years, so they are now in a better position to improve revenue at lower oil prices.
A combination of factors, including global economic growth, continued weakness in the dollar, the ability of OPEC to keep production curbs in place and restraint on the part of U.S. shale producers has helped lift WTI over the $65 mark and convince investors the higher prices are now sustainable,” reports Reuters.
Market observers believe the sector can continue its recent rebound. Current OPEC compliance with production cut plans remains above their historical average, and it usually takes between two to three quarters for inventories to normalize after the cuts. The challenge for energy equities is that some oil market observers see more declines coming for crude. Oil traders are concerned over how fast U.S. shale oil producers will increase production to capture the rising prices.
“While the forward price to earnings ratio (PE) of the energy index at nearly 24 is well above the 18.6 for the S&P 500, that number is set to decrease as the sector has the second highest percentage of upward estimate revisions of the major S&P groups through Thursday morning,” according to Reuters.
Dow components Exxon and Chevron, the two largest U.S. oil companies, combine for about 40% of cap-weighted energy ETFs, such as XLE, 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 oil category.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.