Every so often I review a sector within my portfolio to make sure that the individual positions still make sense. A review of my Energy stocks reminded me how much I despise that sector. Why? Because Energy stocks do not act like normal stocks. They have an additional level of complexity based on the underlying commodity. What I mean is that you can own the most well-run Energy company and still lose money because the underlying commodity is falling in price. So unlike other types of companies, you need to get both of these factors right at the same time.
Why is it So Difficult to Predict the Future Price of Oil & Gas?
Putting on my economist hat, it all comes down to supply and demand, which are volatile, always pulling and pushing on the price every day. On the demand side, you have the consumers and industries (the economy) who are addicted to more and more energy, until they change their minds. You also have other influencing factors such as the weather (e.g. cold winters) and long-term population growth.
On the supply side, you have the Organization of Exporting Countries (OPEC, also known as the evil cartel), which attempts to manage supply (i.e. keep it low) in order to prop up the price in their favour. The 13 Member Countries control about 45% of all world production, which is enough to be very influential in setting the price. The remaining production is at the mercy of geopolitics or in other words, international squabbles. Take Venezuela for example; they decided to nationalize (steal) all foreign oil company assets within their country in 1976, and to a lesser extent in 2007.
Enough with Economics 101. You witness the effect of supply and demand every day at the gas pump when you fill up one of your 2 to 3 cars. Some of the biggest shifts in price come when the world falls into recession (demand falls). More recently on the geopolitical scene, Russia cut off the supply of oil and gas to Europe as retaliation for Ukraine war sanctions. Do you see the problem with Energy? It’s a nightmare! There is no way to figure out where energy prices are going to go with any certainty. It’s a similar story for other commodity-based stocks such as gold, copper, steel, etc.
On the investment side, these companies are what are known as cyclicals, which means they are generally tied to the health of the economy. Cyclicals are much more volatile than other types of stocks as they tend to boom, bust, and then start over. You have to be very careful when investing in cyclicals. In contrast, the Consumer Staple sector (e.g. hotdog makers) sells their goods no matter the economic cycle… same with Health Care. People need to eat and brush their teeth, right?
It’s also worth pointing out that the Energy sector is about more than just oil and gas, further complicating things. Think nuclear, pipelines, exploration, solar, wind, biomass, hydro… it seems never-ending. Even within oil and gas, there are the integrateds, explorers, refiners, drillers, pipelines, and fuel stations, just to name a few. While many have written off fossil fuels as “soon-to-be-dead”, they won’t die that quickly, especially with energy demand increasing each year. Most of the Energy sector is still based on fossil fuels. Only about 11.2 % of world energy production comes from renewables, which sounds promising, but ten years earlier it was 8.7%. Yes, renewables are increasing at a faster rate, but the world won’t change just because you bought a Tesla. That being said, if you listened to the market noise, you’d think that you need to divest oil and gas ASAP so as not to be holding the last barrel of oil. I’ve got news: oil and gas will still be around for decades.
Is There an Energy Strategy?
Oil & Gas
My efforts to game oil and gas have been historically hit and (more often) miss. As mentioned, there is so much randomness at work that it’s difficult to set up strategies that have a high probability of working. Worse yet, if you get it right, a quick swing in oil and gas prices can take back any gains. Any big wins have a big luck component. My only strategy on oil and gas is to buy companies when prices are relatively low, hold an overweight position when no one else wants them, and then wait. I did this (see my earlier post) a little over a year ago when I loaded up on Shell, which has since produced a 50% return. Many years ago when oil was $120+ USD, I did not hold any positions. That’s about it as far as strategies go. It’s still a strategy, however, it’s of the dumbest, caveman type.
Nuclear
My other strategy for Energy was to increase my diversification by investing in Cameco, a Canadian Uranium producer. With the world getting more serious about climate change, and where clean energy will be the answer, nuclear energy is a requirement that no one recognizes or wants. Since the 2011 Fukushima nuclear disaster in Japan, no one globally wants to invest in the industry. Many countries shut down existing plants or at least stopped building new ones. The industry was a dog for years, prices crumbled, and it was dead money.
However, with Russia using its natural gas as a weapon against Europe, many countries are now rethinking nuclear. Even Japan has changed its policies and has plans to reopen shuttered nuclear plants to lower its reliance on foreign energy. The story makes more and more sense because new reactors are safer than previous versions, cost less to build, and are basically zero-emission. Any serious attempt at reaching carbon targets will likely require nuclear. Countries like France have relied on nuclear for decades without any serious issues. It of course has its’ flaws but within the last year or so, the Cameco Position has gone up 62%.
Other alternatives in Energy include solar, wind, geothermal, etc. I like these in general and would love to own some at some point, but every time I try to diversify into one of these, I find that they are too expensive and therefore not a good risk-reward option. One day, I will own some.
Should You Invest in Energy Now?
After these run-ups, I am more inclined to sell and bring my weightings down to full weight (5%), or maybe even underweight a little, particularly on the oil and gas side. For now, I will keep the weighting and play out the strategy. I still believe that over the very long run, barring another disaster, nuclear has a positive runway for years to come. I believe oil and gas may have a decent run back up with winter coming and with the uncertainties with the Russia-Ukraine war. But as always, things can change quickly (e.g. Ukraine invades Russia) and there’s little ability to foresee the future.
Surprisingly Warren Buffett has been buying up Occidental Petroleum by the truckload. Similar to me, he is staying within the safety of big powerful companies in this weird investing climate, so that is a vote of confidence. There are few certainties when it comes to Energy, nevertheless, everyone should have some exposure.
FYI: I own Royal Dutch Shell and Cameco.
How Much Energy Should You Own?
Answer: not a lot. Surprisingly, energy has become less of a player in the world over the years, and it’s small compared to other sectors. To put it into perspective, Apple is worth more than all the S&P 500 Energy sector combined. As of this writing, even with its recent run-up, Energy is still worth less than 5% of the economy. Compare this to the 38% represented by the combined Technology and Communication sectors. Any big gain in such a small sector gets out-competed by the bigger sectors.
My big bet in Energy earlier this year had me at about almost double the S&P 500 weighting or about 5% of the portfolio at the time. Anything more would become too speculative in case I was wrong. So the more specific answer to the above question for any new investors is a little less than 5% portfolio weighting to reflect today’s index weighting. My current weighting is about 6%.
Looking Forward
It’s been a difficult month as the market continues to figure out its value. It’s up big then down big, with a very negative sentiment at the moment. Inflation persists and is likely to continue, which means more rate hikes and a higher probability of a big recession. A recession means lowers earnings, which often translates to falling stock values, but not always. In the short run (one year or so) volatility will continue, so it’s best to stay heavily diversified for now. Volatility works both ways, so the market could go up, which no one is expecting.
Marc’s Monthly Moves
- Nada.
Marc’s Portfolio YTD Performance
My portfolio page is now LIVE! It will be updated monthly and contains my full list of positions as well as the performance information that I’ve included below.
- Portfolio return: -14.6% (including currency gains)
- Portfolio return: -22.0% (without currency gains)
- S&P 500 return: -22.51%
- TSX: -12.92%
The portfolio overperformed the S&P 500 by 0.5 percentage points.
Money with Marc 