This Chilling Forecast Will Send Shivers Across the Oil Patch
Demand is drying up much faster than expected.
The energy sector produces and supplies fuels and electricity for the global economy. It includes companies involved in the following activities:
This broad industry is crucial to providing the economy with the energy it needs. It's also an important one for investors to understand.
Hundreds of public companies focus on the production and distribution of energy. However, a few leaders stand out, not only for their size but also for the strength of their financial profiles. Here are three of the top ones:
|Company||Ticker||What it does|
|ConocoPhillips||NYSE:COP||Globally diversified oil and gas producer|
|NextEra Energy||NYSE:NEE||Leading utility and renewable energy producer|
|TC Energy||NYSE:TRP||Leading pipeline operator and electricity producer|
Source: Companies' websites
This oil and gas producer ConocoPhillips (NYSE:COP) is diverse geographically (it has operations around the world) and in terms of extraction method. The company operates deepwater wells, oil sands production complexes, liquified natural gas (LNG) production and export facilities, and conventional and unconventional (i.e., shale) oil and gas wells. The company also enjoys low-cost operations, with a large portion of its resource base costing less than $40 a barrel to produce.
ConocoPhillips complements its low cost of supply with a strong balance sheet. It has an investment-grade bond rating backed by a low leverage ratio and lots of cash. That provides it with plenty of cushion to weather periods of low oil and gas prices, which has certainly been the case in 2020. While COVID-19 forced ConocoPhillips to alter its game plan, the oil giant will survive this downturn, which hasn’t been the case for many of its weaker rivals.
NextEra Energy (NYSE:NEE) is one of the country's largest electric utility companies. It's also the global leader in producing power from the wind and sun through its energy resources segment, which sells clean energy to other utilities and end users around the country. Both businesses generate relatively stable cash flow backed by regulated rates and fixed-price contracts on the power it produces and distributes to customers. This business model has proven its resiliency during COVID-19, as NextEra faced minimal impacts thanks to steady electricity demand and rates.
The company also boasts one of the best balance sheets in the electric utility sector, including one of the highest credit ratings in its peer group. It also has a conservative dividend payout ratio for a utility, which adds to its strong financial profile.
One of the largest natural gas pipeline operators in North America, TC Energy (NYSE:TRP) has pipes in the U.S., Mexico, and its home country of Canada. The company also owns a premier liquids pipeline system, including its status as one of Canada's leading oil exporters and largest power producers.
Those energy infrastructure assets generate relatively stable cash flows, backed primarily by fee-based contracts and regulated rates. This low-risk business model has proven to be highly durable during COVID-19, as TC Energy continued to generate steady cash flows. Meanwhile, the company pays out a conservative amount of its annual earnings via its dividend and has one of the top credit ratings in the pipeline sector. Those factors provide it with the financial flexibility to continue expanding its pipeline network while also making TC Energy one of the lower-risk companies in the energy sector.
The energy sector is a challenging one for investors. Energy prices can change in a heartbeat, which can have a massive impact on the sector as well as the global economy. That became abundantly clear at the start of the COVID-19 pandemic of 2020. The outbreak shut down large portions of the global economy, like air travel and commuting to work, which torpedoed oil demand and pricing. This downturn weighed heavily on oil company stock prices, with some ending up worthless as several companies filed for bankruptcy.
Because of the impact commodity price volatility can have on the energy sector, investors must keep downside risk in mind. That means not allocating too much of their portfolio to one energy stock or the industry as a whole. Further, they should focus on companies unlikely to go out of business if industry conditions deteriorate significantly.
Factors that increase an energy company's durability include:
Energy companies with these characteristics will be in a better position to withstand the inevitable downturns. That means not only that they'll still be around when conditions improve, but also that they have more flexibility than their weaker peers to capture opportunities that can create value for their investors.
The energy sector is vital to the global economy because it provides the fuel and power needed to drive trade and travel. However, when the economy slows, which was the case during the height of the COVID-19 outbreak, it can have a major impact on energy demand and prices, which weighs on stock prices. Because of that, investors should focus on the stocks of companies that can easily survive a downturn, since that also puts them in the best position to thrive when market conditions improve.
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