In 1978, seeing that a career as a university professor was not going to pan out for me (in hindsight, what a stroke of luck!!), my job search landed me as a trainee at Value Line. That was the best of times for the publication, which had become a safe harbor for seasoned securities during the severe 1973-74 recession and the simultaneous end to the fixed commission regime the traditional brokerage industry relied on for its profits. As the recession waned, however, and as brokerage firms adjusted, the immense amount of intellectual property the firm had collected began to set sail for more lucrative shores.

I got a job as a trainee analyst on the strength of my ability to write a coherent English sentence and to add and subtract. Six months later, the brain drain had become so severe that I was suddenly the head oil analyst–a sector that was on fire, and that then comprised about 20% of the capitalization of the S&P 500. The friend who was mentoring me said that this meant I’d have a job forever.

Today that number is under 3%. Oil has joined gold, coal, base metals and utilities on the stock market scrap heap.

how I approach Energy

Over the past three years, the S&P 500 has made an average annual gain of +20%

Over the same period, the Energy sector as made an average annual loss of -3.8%.

What this says to me is that Energy is not a buy-and-hold sector. Add to that the facts that the sector is tiny, that natural resources accounting is unusual and that off-balance sheet data are crucial to understanding the companies, one could argue that our time would be better off spent on, say, technology or consumer discretionary stocks, where there may be greater bang for our research efforts. This has been my general approach.

An alternative strategy, probably taken more by working professionals than now-part-timers like me, is to neutralize the sector by holding a market weighting–and possibly also replicating, stock by stock, the S&P index weightings. Yes, you tie up 3% of your portfolio, but the sector won’t hurt you and you don’t have to acquire and maintain the specialized knowledge needed to be successful here. So you probably have 10% more time to work on outperformance elsewhere.

…however…

Year-to-date through yesterday, the S&P is up by +22.4%. Energy is up by +53.5%. That’s after having been down by -37.3% in 2020, a year in which the S&P gained 16.3%.

In other words, Energy has recently been a boom or bust affair. To me, this reinforces value of the ignore/neutralize strategy. On the other hand, the sector’s rollercoaster character does give it some speculative appeal.

Three things to note:

–around 1900 coal began to replace firewood; around 1950 oil began to replace coal; and 2000-ish renewables began to replace oil. In other words, oil and gas are no longer an expanding industry.

–the oil price is determined to a great degree by OPEC, a group whose members are often at loggerheads with one another–and which doesn’t include major producers like Russia and the US. So the politics of oil need to be monitored.

–medium-sized “wildcatter” exploration companies are often very highly financially leveraged. Security for these borrowings is most often the present value of economically recoverable but yet to be pumped out of the ground oil/gas the company owns. This PV is not a static number. It can fluctuate considerably as hydrocarbon prices rise and fall. Bank loans may have covenants that require accelerated repayment if the PV falls below, say, 3x the outstanding borrowings. You may have to dig through the financial footnotes, bond indentures and/or the 10-K to find this out.