If you are a day trader, a winner emerged from last week’s bombing of the Saudi oil fields: oil and gas investors. By the end of the trading day on Monday, a key oil and gas stock portfolio (an ETF called XOP) had shot up more than 10 percent, with some U.S. oil stocks gaining nearly 50 percent in a single day.
Does this mean that the oil and gas sector has staged a comeback on Wall Street? Far from it. Monday’s price spike underscores a key reality in today’s oil and gas sector: energy stocks have become speculative, volatile, and increasingly ill-suited to portfolios designed for long-term growth.
Investors with perspectives longer than a day trader’s remember that the oil and gas sector has produced abysmal returns for years. At the end of August, the oil and gas stock portfolio that spiked last Monday was down 14% for the month, 49% over the year, and 22% over the previous five years. Just as importantly, the stock bump from the Saudi attack faded quickly, with the portfolio giving up most of its gains by the close of trading on Thursday.
Some of the companies that rose so quickly on Monday have been among the sector’s biggest long-term losers. Take Whiting Petroleum. The stock rose an astonishing 45 percent on the Saudi news, rising from $7.54 per share at the end of the prior week to more than $11 at the closing bell on Monday. Yet just five years ago, Whiting’s stock traded at more than $320 per share. Monday’s outsized returns were a mere blip in a long-term rout.
Many of the financial problems in the oil and gas sector stem from the rise of fracking in the U.S., undertaken by companies like Whiting. Fracking-focused companies consistently spend more on drilling than they generate from selling their product, resulting in a decade of negative cash flows and a rash of bankruptcies. Steve Schlotterbeck, former CEO of EQT, the nation’s largest gas producer, recently described the natural gas fracking industry as “an unmitigated disaster for any buy and hold investor.” Even companies that have avoided fracking entirely have been caught in the downdraft, as rising output from fracking has kept oil and gas prices low.
The underperformance of the oil and gas sector poses a growing challenge to investment managers. Long gone are the days when passive investors could pour money into a broad basket of energy stocks, expecting decent returns. Making money in oil and gas now requires detailed company-by-company knowledge, and a willingness to make bets on specific stocks that might exceed expectations.
That’s the approach being taken by Norway’s sovereign wealth fund, the world’s second-largest. The fund has banned passive investments in a broad swath of oil and gas producers, on the grounds that the sector as a whole has become too risky. Fund managers can make selective investments in the sector, but only after careful consideration. This vote of no-confidence was all the more astonishing, considering that Norway’s oil industry has provided most of the capital for the nation’s wealth fund.
Other pension funds are widening their divestment to include the broader fossil fuel sector, which has underperformed the Standard & Poor’s 500 for a decade. The University of California announced recently that it would fully divest all its fossil fuel holdings, citing the financial risk to its $126.1 bn portfolio. “The reason we sold some $150 million in fossil fuel assets from our endowment,” wrote the school’s CIO and chair of the investment committee, “was the reason we sell other assets: They posed a long-term risk to generating strong returns for UC’s diversified portfolios.”
The underperformance and rising risk profile of the oil and gas sector is fueling the growing movement towards divestment from fossil fuels. And Wall Street has had no choice but to follow the movement’s trajectory: fossil fuel divestment has progressed organically, as the energy sector’s share of the market has dwindled. In 1980, energy companies represented 28 percent of the S&P 500. That’s fallen now to just over 4 percent. Even passive investors are divesting, if only unintentionally.
And while some portfolios are publicly announcing their retreat from oil and gas, many investment managers are doing what’s known as the “Wall Street Walk:” they’re pulling out of fossil fuels, quietly and without fanfare. They’ve figured out what the divestment movement understood long ago: oil and gas companies have become too risky, for too little reward.
Kathy Hipple ([email protected]) is an IEEFA financial analyst.
Clark Williams-Derry ([email protected]) is Director of Energy Finance for Sightline Institute.
Tom Sanzillo ([email protected]) is IEEFA’s director of finance.