Elevated oil and gas prices have buoyed energy company profits during the past two quarters. The solid financial results have prompted many energy companies in this sector to return cash to investors via dividends. According to a Bloomberg survey, more than 44% of the managers that responded intend to increase their exposure to the energy sector during the next six months. Despite oil and gas price volatility, the energy sector might continue to outperform as oil and gas prices remain elevated. For the nine months ending September 2022, the energy sector gained nearly 32%.
Measuring Value using Forward Price to Earnings
The Energy sector looks relatively attractive by some metrics. According to oilprice.com, as of Q3 2022, the forward price-to-earnings ratio for energy shares is less expensive than other sectors. The forward price-to-earnings ratio divides the current price of a stock or an ETF by the forward earnings number. Since no one knows the forward earnings number, this gauge is an estimate of analysts who project how much a company or a group of companies will earn in a future period. Alternatively, the forward price-to-earnings figure can come from a forecast directly from the company.
The forward price-to-earnings ratio differs from the price-to-earnings ratio in that it gauges the current price value relative to future earnings as opposed to past earnings. The forward PE is usually based on the likely earnings per share during the next 12 months.
Despite a strong performance already in 2022, the forward price-to-earnings metrics still show that some stocks within the energy sector are still inexpensive. According to Yardeni Research, the energy sector is the top-performing sector in the S&P 500 through mid-October 2022.
Are Oil Companies Helping Investors?
While the value of many energy companies continues to make them attractive, there is also an additional benefit to investing in these companies. Oil companies are using these elevated levels of crude oil trading in India for investor benefit. According to BailoutWatch.com, during the first five months of 2022, eight energy companies authorized buybacks of 46 billion in equity. When a company buys back its shares, it reduces the outstanding shares in the marketplace and increases the value of the stack to the owner of the shares. Companies will often buy back their shares because the management believes the company share price is undervalued.
As oil prices surged in February 2022 in the wake of the beginning of the conflict between Ukraine and Russia, energy companies authorized $36 billion in buybacks. Additionally, seven companies announced they are paying a special dividend on top of their regular dividend. A special dividend is a way for a company to allow an investor to make sure they are receiving a large portion of the windfall in profits.
Earnings Have Been Robust
Ahead of Q3 earnings, energy companies have made hay in 2022. The question for investors is whether energy companies will continue with their fiscal discipline and reward shareholders with solid profits and dividends. Historically, energy companies had benefited from higher oil prices only to lose out when demand declined during a global recession. Energy companies’ investments to increase production during good times did not pay off during the ensuing pullback in economic growth.
The energy sector was the most significant contributor to earnings growth for the S&P 500 index in Q2 2022. According to Factset, the energy sector reported an aggregate year-on-year increase in earnings of 47.7 billion, while the overall S&P 500 index reported earnings of 31.1 billion. If the energy sector had been excluded from the S&P 500 index, the large-cap index would have reported a decline in year-over-year gains.
Portfolio Managers are Upbeat on Energy
The substantial profits and low forward PE ratio have buoyed portfolio managers’ sentiment. The latest MLIV Pulse survey by Bloomberg of 814 respondents shows that about 66% intend to increase their exposure to energy-related securities during the next six months. Nearly 75% of the managers and retail investors who responded to the survey said they expect natural gas and electricity to drive inflation during the winter. The majority said that if there is any shortfall in essential fuels over the next six months, it would be in the natural gas sector.
The respondents to the survey believe that oil prices will remain between $70 and $139 during the balance of 2022. About half the respondents believe that the energy crisis will accelerate the pace of green power generation.
Short-Term Heating Outlook
The forecast of higher heating bills and higher demand due to colder temperatures is forecasted by the Energy Information Administration. The EIA forecast predicts that the average household cost of heating fuels will increase this winter because of higher prices and higher demand. The EIA forecast also predicts that costs for homes that heat with heating oil will rise by 27%. Home heating with natural gas will see a 28% increase in their bill. The Energy Information Administration sees global fuel demand rising by more than 2 million barrels daily in 2022 and an additional 1.5 million in 2023.
Natural gas demand is also expected to rise in 2022, but the EIA sees a decline in consumption in 2023 as growth starts to decline. The EIA sees natural gas consumption rising by nearly four BCF per day in 2022. Demand is driven by electricity. Electricity sales are expected to rise in the United States by 3% yearly. Natural gas continues to take market share in the United States regarding power generation. In 2022 natural gas power generation made up 38% of total generation, up from 37% in 2021.
Crude oil production in the United States is expected to average 11.7 million barrels per day in 2022 and then increase to 12.4 million barrels per day in 2023. The increase reflects more U.S. producers taking advantage of higher prices but not a massive increase in production, which would show that energy companies were spending more than projected.
The forward price-to-earnings ratio of Exxon Mobile, the largest integrated energy company in the United States, is about 9.4. Over the last six years, the highs have been as lofty as 39, and the PE of XOM has been above 35 in two periods separated by four years. While the PE can continue to fall, it is much closer to the bottom of a forecasted PE estimate than it is to the top. Energy companies could likely continue to experience robust earnings even with declining growth.
In the wake of the Russia/Ukraine conflict, the United States released barrels from its strategic petroleum reserve to fend off higher oil prices. The selling of reserves put pressure on prices, eventually forcing OPEC to act. To reverse the trend and help buoy prices, OPEC announced they would cut production.
To fend off a potential rise in prices ahead of the U.S. mid-term elections, the Biden administration asked Saudi Arabia to delay its decision on oil output by a month. The administration’s goal is to put off any potential increase in gasoline prices ahead of the mid-term elections. OPEC has defended its choice based on its view of global growth. The Biden administration said they have conveyed to the Saudis that by increasing the price of oil, they are growing Russian revenue and blunting the effectiveness of sanctions.
The Bottom Line
The upshot is that energy companies seem to be sitting in the catbird seat for the first time in a while. While returns for 2022 have been spectacular, the recent rally reflects a sector that has been neglected. The real advantage for energy companies is that they could likely continue to make money as the world transitions to alternative energy sources.
The move to alternative sources has left the industry with investors who are looking for short-term gains. The newest refinery in the United States that has significant capacity is the Marathon facility in Louisiana, which was built in 1977.
If there is little investment in the future of the oil and gas business in the United States, it will be challenging to expand, which leaves the supply in just a few hands. Most current energy companies will have access to higher prices but will not face any competition since no new companies plan to enter the oil and gas arena. New energy companies will likely focus on electric energy, including wind and solar power companies, battery manufacturers, and lithium and cobalt producers.
The transition to new energy has reduced competition, which will only equalize when more people start to use alternative energy sources.
In conjunction with shares, buybacks, and solid dividends, a low forward price-to-earnings ratio makes energy companies a great point of interest for online traders. With fewer energy companies coming online and higher prices likely to remain, established energy companies that pay a robust dividend will likely hold steady given the low forward PE and provide their investors a return even if prices fail to move higher.