By Lee Clements, Head of Applied Sustainable Investment Research, Global Investment Research
Energy and persistence conquer all things, said Benjamin Franklin, but is persistence in the energy markets the right thing for long term investors?
The energy market has certainly had a very positive year so far. FTSE All World Oil, Gas & Coal is up 20% YTD (to end August), 39% ahead of the broader FTSE All World Equity Index. This is unsurprising given the 24% rise in Brent crude prices, the unprecedented impact to energy supply from the Ukraine war and an average 56% and 128% increase respectively in estimated revenues and EPS for the top 5 members of the index (2022 over 2021).
This comes on top of energy have been a significantly overlooked sector, underperforming FTSE All World for 8 of the previous 10 years. It has run counter to the performance of green economy stocks, as measured by the FTSE Environmental Opportunities All Share Index, which has outperformed the FTSE Global All Cap for 7 of the previous 10 years, but which is underperforming it year to date.
Looking more broadly across asset classes, whilst energy equities were strong (and less in utilities and basic materials), but energy bonds have not been so strong. Investment grade energy issuers lost 13.6% year to date, impacted by rising interest rates and 0.8% behind the WorldBIG investment grade corporate bond index (you would have gotten a better return from investment grade corporate green bonds). In high yield, the more natural place for small energy companies, energy bonds were 4.3% ahead of the FTSE High Yield Index, but still a -6.4% return. The highest investment returns have been made in commodities, most direct benefiting from the price increase as well as being an inflation hedge and arguably having less ESG aversion in owning oil futures than owning oil companies. Brent crude prices have considerably outperformed energy equities since the low of oil prices in April 2020 and year to date European gas has been the particularly outperformer, given the impact of shutting off Russian gas supplies on the market.
However, the performance of the energy sector year to date has not been backed by significant volume. Whilst natural resource funds saw inflows in Q1 they saw significant outflows in the last 3 months (and the strongest inflows were back in 2020). In addition most large energy stocks and key energy futures have not seen significant increase in volumes.
Looking to the future it is also difficult to see the strong positive future signals for the sector, estimated average revenue and EPS growth for the same top 5 energy companies are -10% & -12% for FY23 and -12% & -18% for FY24. The oil market is also in significant backwardation, with the front end of the curve for Brent (Dec 22) having gone up $20 YTD, but the longer end of the curve (Dec 25) only $4. You also haven’t seen a significant growth in the rig count in response to the raised oil prices, with the current count of 605 only up from 480 at the of 2021. This is well above the pandemic low of 180 (in July 2020) but still way below the 1,000 plus rigs last time WTI was above $95 (in the 2011-2015 period). This is beneficial to keeping oil prices high, but may indicate a lack of conviction in their long term direction.
Short term supply conditions and government plans are positive for energy markets, with European countries in particular trying to stimulate local production and search for non-Russian supply. However there are also more concerted plans to boost alternative energy, such as RePowerEU and the US Climate Bill and decouple power markets from fossil fuels prices, which could weaken future demand growth and act as structural headwinds to the oil price.
This all leads to the tricky question of whether the energy market is more suited to short term commodity traders or long term asset allocators. Balancing geo-politics, energy security, sustainability/climate change issues and overall demand makes determining likely future returns challenging. Similarly the current toxic triangle of inflation, rates and recession make determining correlation between energy and other assets classes (or determining correlation between any asset classes) challenging and some of traditional correlations, such as the negative relationship between the US dollar and oil prices, have weakened so far this year.
If only we’d remembered to charge our crystal ball!
For more on SI performance, and that of other asset classes, subscribe to our blog.
© 2022 London Stock Exchange Group plc and its applicable group undertakings (the “LSE Group”). The LSE Group includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE Global Debt Capital Markets Inc. and FTSE Global Debt Capital Markets Limited (together, “FTSE Canada”), (4) FTSE Fixed Income Europe Limited (“FTSE FI Europe”), (5) FTSE Fixed Income LLC (“FTSE FI”), (6) The Yield Book Inc (“YB”) and (7) Beyond Ratings S.A.S. (“BR”). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, YB and BR. “FTSE®”, “Russell®”, “FTSE Russell®”, “FTSE4Good®”, “ICB®”, “The Yield Book®”, “Beyond Ratings®” and all other trademarks and service marks used herein (whether registered or unregistered) are trademarks and/or service marks owned or licensed by the applicable member of the LSE Group or their respective licensors and are owned, or used under licence, by FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, YB or BR. FTSE International Limited is authorised and regulated by the Financial Conduct Authority as a benchmark administrator.
All information is provided for information purposes only. All information and data contained in this publication is obtained by the LSE Group, from sources believed by it to be accurate and reliable. Because of the possibility of human and mechanical error as well as other factors, however, such information and data is provided "as is" without warranty of any kind. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the accuracy, timeliness, completeness, merchantability of any information or of results to be obtained from the use of FTSE Russell products, including but not limited to indexes, data and analytics, or the fitness or suitability of the FTSE Russell products for any particular purpose to which they might be put. Any representation of historical data accessible through FTSE Russell products is provided for information purposes only and is not a reliable indicator of future performance.
No responsibility or liability can be accepted by any member of the LSE Group nor their respective directors, officers, employees, partners or licensors for (a) any loss or damage in whole or in part caused by, resulting from, or relating to any error (negligent or otherwise) or other circumstance involved in procuring, collecting, compiling, interpreting, analysing, editing, transcribing, transmitting, communicating or delivering any such information or data or from use of this document or links to this document or (b) any direct, indirect, special, consequential or incidental damages whatsoever, even if any member of the LSE Group is advised in advance of the possibility of such damages, resulting from the use of, or inability to use, such information.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing in this document should be taken as constituting financial or investment advice. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any representation regarding the advisability of investing in any asset or whether such investment creates any legal or compliance risks for the investor. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset nor confirmation that any particular investor may lawfully buy, sell or hold the asset or an index containing the asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back-tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.
This document may contain forward-looking assessments. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking assessments are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially. No member of the LSE Group nor their licensors assume any duty to and do not undertake to update forward-looking assessments.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of the LSE Group. Use and distribution of the LSE Group data requires a licence from FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, YB, BR and/or their respective licensors.
