Shares in the energy patch took a beating in 2020, but this slice of US equity sectors has posted a strong rebound so far in 2021, based on a set of exchange traded funds. Encouraging, but it’s unlikely that stocks in the conventional realm of energy are gearing up for an extended bull run.

Climate-change risk is gathering momentum, which is no trivial factor for conventional energy stocks. The business opportunities are brighter for alternative energy firms, but these shares have already surged and are arguably pricing in much of the good news for the foreseeable future.

Let’s start with conventional energy stocks, based on Energy Select Sector SPDR (XLE), which is dominated by the likes of old-school behemoths such as Exxon Mobil, Chevron and Phillips 66. Big oil’s prospects face substantial regulatory and market challenges in the years ahead, even though XLE has enjoyed a strong bounce year to date after shedding nearly 33% in 2020.

XLE’s 6.1% gain so far this year stands out against mixed results for the rest of the main US equity sectors, based on trading through yesterday’s close (Jan. 27). The pop is impressive on a relative basis, but keep in mind that XLE’s recent gains follow much bigger losses previously and so its 2021 leadership may be less about brighter prospects vs. the temporary effects of a dead-cat bounce.

Even before the coronavirus shock, traditional energy stocks faced an increasingly hostile environment as the green revolution unfolded. The arrival of the Biden administration in Washington is expected to accelerate that revolution. As a signal of priorities for energy policy in the years ahead, President Biden yesterday announced a pause in oil drilling on public lands.

The market and regulatory climate are significantly more favorable for various flavors of so-called alternative energy companies. But that’s old news from an investment perspective and much of the new order for energy shares are already pricing in a bullish future.

For example, consider performances for three alternative energy ETFs (PBW, TAN and FAN) over the past year vs. the broad US stock market (SPY) and XLE. Invesco WilderHill Clean Energy (PBW) and First Trust Global Wind Energy (FAN), in particular, have soared, pushing up their respective portfolio valuations to relatively high levels.

There’s certainly a macro driver here, and one that’s likely to power the business of clean energy for the long haul. The key investment question, as always, is how much to pay for this rosy forecats? By contrast, big oil is a sunset industry. The challenge for investors is that the crowd has already revised expectations accordingly. For example, Bloomberg reports that “clean-energy companies are raising record amounts of cash through stock offerings in what could be their biggest funding opportunity ever as U.S. President Joe Biden moves to implement his climate agenda.”

In other words, the low-hanging fruit has been picked. Energy stocks still deserve a spot in a diversified portfolio, but investors need to be selective and mindful of the potential for unusually high volatility that resides in shares of old and new energy shares.  

---

Learn To Use R For Portfolio Analysis
Quantitative Investment Portfolio Analytics In R:
An Introduction To R For Modeling Portfolio Risk and Return
By James Picerno

---