What happened
Shares of integrated energy giant ExxonMobil (XOM 0.23%) rose as much as 5% on Nov. 23. ConocoPhillips (COP 0.64%), which is focused on exploration and production, was higher by 6%. And refiner and midstream player Phillips 66 (PSX -0.35%) was up 5%. This trio covers a lot of ground in the energy sector, showing just how widespread the good mood is today. But it's important to dig a bit deeper here.
So what
Exxon plays in a rarefied field of Goliath energy companies including names like Chevron (CVX 1.04%), Royal Dutch Shell (RDS.B), and Total (TTE 1.39%), each of which had notable 4% gains today. The main business model here is really diversification across the entire energy landscape, from the upstream (drilling) to the downstream (refining and chemicals) -- and a lot that's in between (the midstream). The hope is that some businesses will be doing well while others are weak and they will offset each other to some degree. Only that hasn't happened during the current downturn, which has punished every portion of the energy industry.
Image source: Getty Images.
The difference this time is the coronavirus. The economic shutdowns being used to slow the spread of COVID-19 have upended models through the sector, as falling economic activity has reduced demand and, thus, pricing across the board.
Interestingly, refiner Phillips 66 and driller ConocoPhillips show just how big an issue this has been, because the two companies were once combined into one larger entity, like the integrated oil majors. The split allowed each to focus on their specific niche, but both stocks are off by more than a third so far in 2020 and bleeding red ink. And it was the rapid decline in demand for both oil and natural gas and the products into which they get turned that is to blame. It is a frightening development, punctuated by the decline of West Texas Intermediate oil below zero at one point early in the year. Oil prices have since recovered, but they remain painfully low.
Broadly speaking, the energy industry is doing what it needs to do to survive, including cutting costs, reducing production, and taking on debt to ensure near-term liquidity. But some companies aren't particularly well positioned, such as Exxon, which entered the downturn with huge spending plans to help reverse years of production declines. It wants to keep its dividend intact, something that debt-laden Shell wasn't able to do, but it is going to be tough to pull off. Chevron and Total both appear to be in better position to keep paying investors through this downturn, but that hasn't saved the stocks from material declines in 2020.
Phillips 66 and ConocoPhillips have managed to maintain their dividends throughout the year, suggesting that the earlier breakup has worked out well for their respective businesses. In fact, ConocoPhillips actually increased its dividend by a token penny a share in October in a show of financial strength. That could become even more important in the next few months if investors are right about the direction of energy demand.
The improved outlook today is all about the trio of vaccines that are working through the approval process. One vaccine a week in each of the last three weeks has shown at least 90% effectiveness against the coronavirus. The latest upbeat vaccine results were released today from AstraZeneca. That suggests that the world could soon move past COVID-19 fears and start to get back to a more normal status. A material increase in demand for oil and natural gas, and the many products into which they get turned, would likely follow close behind. And, thus, investors boosted the stocks of some of the largest names in the energy sector, as well as tiny names.
Now what
The problem is that investors may be getting ahead of themselves a little bit, since it will take months, if not quarters, for a vaccine to be widely distributed once it is approved (which also has yet to happen, by the way). In fact, the energy industry is notoriously volatile, so today's gain could easily reverse course if investors find a reason to turn negative again. Investors looking at the energy sector for bargains should probably stick to the larger names, like those here, and focus on those with the best financial and industry positioning. That limits the list, but it still leaves a few prominent options, including Chevron and Total.
