What is the Energy Sector?
The energy sector is a category of companies in the business related to the production and supply of energy. According to the Global Industry Classification Standard (GICS), the energy sector covers the companies that explore, produce, refine, market, store, and transport oil and gas, coal, and other consumable fuels. Companies offering oil and gas equipment are also considered part of the energy sector.
- Companies involved in the exploitation, storage, production, transportation, and distribution of energy are categorized into the energy sector.
- The external drivers of the energy sector include the economic activity level, weather and seasons, as well as government regulations and organization policies.
- The energy sector is subject to risks in changing environmental policies, which leads to a trend of investing in renewable resources.
Overview of the Energy Sector
The energy sector consists of a large group of inter-related companies that cover a wide variety of energy. The two major types of energy are as follows:
- One is non-renewable energy, which includes oil and petroleum products, gasoline, natural gas, diesel fuel, and nuclear.
- The other one is renewable energy, such as hydropower, solar power, and wind power.
Energy businesses incur large capital expenditures, and they own large amounts of fixed assets. Such assets include land for oil reserves, plants and equipment for crude oil and raw natural gas processing, and infrastructure or transportation.
Energy companies also make substantial spending on research and development (R&D) to update technology in drilling and processing to improve efficiency and adapt to the changing environmental policies.
Components of the Energy Sector
The GICS further divides the energy sector into the energy equipment & services industry and the oil, gas & consumable fuels industry.
1. Energy Equipment & Services Industry
The energy equipment & services industry comprises oil and gas drilling contractors, manufacturers of drilling equipment, and businesses that provide services related to drilling and completion of oil or gas wells. Helmerich & Payne, Inc., Unit Corporation, and Exterran Corp. are some of the players in the U.S. energy equipment & services industry.
2. Oil, Gas & Consumable Fuels Industry
Companies in the oil and gas industry can be categorized into the upstream, the midstream, and the downstream. They have different positions in the supply chain.
- The upstream companies are involved in exploring potential crude oil and natural gas fields. They also exploit these energy resources through drilling and operating wells. Mergers, acquisitions, and divestitures happen in the upstream frequently.
- The midstream provides storage, transportation, and wholesale marketing for oil, gas, and petroleum products. Transportation providers include pipeline transportation companies, barge companies, railroad companies, and other logistics companies.
- The downstream is involved in post-production activities. The downstream companies refine crude oil and raw natural gas into consumable fuels, such as gasoline, diesel fuel, and jet fuel. They also distribute derived products such as waxes, lubricants, and many other petrochemicals. The midstream is often considered a part of the downstream.
Factors that Impact the Energy Sector
The energy sector is highly cyclical and sensitive to the macroeconomic environment. The level of economic activities exerts a significant impact on the demand for oil and gas. GDP, disposable income, employment, new housing, and the industrial production index are some of the macroeconomic drivers.
During expansion periods, an increasing amount of business activities and production inflates the demand and price of oil. During recessions, decreasing production level lowers the demand and price, and thus weakens the sector.
In addition to the economic condition, the weather and seasons also impact the energy sector. Gas prices are usually higher in the summer than in the winter. It is partially due to more traveling in the summer, and partially due to higher production costs for the summer-grade fuels. Severe weather conditions, such as hurricanes, and natural disasters can damage infrastructures and disrupt the supply of energy.
Strong and stable oil prices usually indicate economic health. Thus, some organizations coordinate energy suppliers and stabilize the markets. The Organization of Petroleum Exporting Countries (OPEC) is one of them. It is an intergovernmental organization that accounts for more than 40% of the oil production all over the world. It coordinates 13 member countries to regulate oil production and supply to impact the oil price.
Investing in the Energy Sector
The energy sector provides several investment options for interested parties. Investors can purchase individual stocks or invest in mutual funds and exchange-traded funds (ETFs). An ETF can provide investors with a diversified portfolio by tracking an underlying index. The SPDR S&P Oil & Gas Explore & Prod ETF (XOP) tracks an equally weighted portfolio of U.S.-based oil and gas exploration and production companies. It is more diversified than a cap-weighted ETF.
Investors can also purchase commodities through futures and options contracts. For example, the New York Mercantile Exchange (NYMEX) offers the NYMEX WTI Crude Oil Futures (CL). It is the most liquid crude oil contract in the world.
NYMEX also provides the RBOB Gasoline Futures and NY Harbor ULSD Futures in the subgroup of refined products, as well as many other energy products. Any companies sensitive to the price change of energy can hedge their risks by holding such contracts.
CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.
To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below: