The Energy Investing Sector: Opportunities and Challenges

The energy market has been changing rapidly and will continue to do so for some time. While renewables only have a minuscule piece of that market so far, and coal is slowing down, oil and gas are enjoying the “energy renaissance.” 

After two fairly moribund decades, about 2010 the oil patch blossomed anew with the advent of hydraulic fracturing, or fracking. “Unconventional drilling has changed the landscape for energy investing,” says John Dowd, portfolio manager of Fidelity’s Select Energy, Select Natural Resources and Advisor Energy Fund.

Fracking rigs drill vertically and often then horizontally into deeply buried, massive shale formations to extract veins of oil and gas. Sand, chemicals and tons of water are pumped into the shale to fracture the stone and force fuels to the surface. While shale oil is not new, the technology and equipment to harvest it efficiently was only recently developed. 

As a result, the U.S. has now surpassed Saudi Arabia as the world’s largest producer of oil and gas–keeping prices of both reasonable, according to the Institute for Energy Research. Reliance on foreign oil has dropped as oil production has grown dramatically. Over 13,000 rigs, up from 700 since 2010, now dot the four big shale basins in Texas, North Dakota and Pennsylvania.

But this explosive growth has created environmental headwinds that have bedeviled the industry’s image and could slow its growth. For instance, according to Reuters, on Tuesday the state of Pennsylvania “sought a record $4.5 million penalty from EQT Corp., a natural gas producer, for damage caused by the release of fracking fluids from a gas drilling site in the Marcellus region.” If too many incidents of environmental damage occur, industry profits, along with investor enthusiam, could shrink.

For now, though, this energy renaissance is helping to drive the U.S. economic recovery and creating new investment opportunities.

Energy has been a profitable long-term investment. But in the past few months, oil prices, normally about $100 a barrel, retrenched to $90, driving down stock prices of many oil companies. While the price could go lower before it comes up, this could be a good time to buy, says Edward Youngberg, a senior energy analyst for Edward Jones. “Generally I think it’s a good opportunity now that there’s a pullback, and everything is 20% off.”  

Three Kinds of Firms

There are basically three kinds of oil and gas companies: exploration and production (E&P) companies, which locate and extract deposits; infrastructure companies, which transport and store oil and gas; and service companies, which build equipment, map geological formations and generally assist E&P companies.       

E&P companies are risky because they track oil prices. Many of them are also weighted down with huge capital investments in shale basin properties, advanced technology to find and place rigs efficiently and new, more automated high-tech rigs (some of which can “walk” from one site to another).

To shop among them for investment purposes, analysts agree that investors and their advisors should look for low costs, full balance sheets and great management. You want companies “whose costs are lowest and have a good reservoir and good technology,” says Dowd. “Companies that own property with untapped supplies that bought an oil field 10 to 15 years ago would be very profitable.”

He thinks EOG Resources, Anadarko, and Noble Energy should be able to deliver superior growth. 

Youngberg also likes Marathon and Devon because they’re good companies that are undervalued. You would own the bigger integrated companies, the “super majors,” like ExxonMobil, Chevron and ConocoPhilips for the dividend, he says, because they are too big to grow much, However, many oil giants are divesting overseas and offshore operations to focus on U.S. shale.