Energy stocks are hardly gassed, even after a two-year run

The energy sector, which led the U.S. equity market in 2021 and 2022, likely has more gas in its tank, according to Fidelity’s Matt Fruhan, driven by strong demand and high prices for oil, as well as other commodities.

“A decade’s worth of underinvestment has led to a long-term supply/demand imbalance,” says Fruhan, portfolio manager of Fidelity^® Large Cap Stock Fund (FLCSX), explaining his rationale for overweighting energy stocks for the past several years.

Fruhan explains that new drilling projects for oil and natural gas have been disincentivized as the world seeks to transition from fossil fuels to green energy. “This shift to green energy is important to preserve the health of the planet,” Fruhan acknowledges, “but it’s expensive and won’t happen overnight. In the meantime, too little is being produced from traditional fossil fuels to keep pace with strong demand.”

The ongoing war in Ukraine has only exacerbated this supply/demand imbalance, Fruhan underscores, while sharply rising interest rates makes it even costlier to finance energy exploration projects.

With commodity prices remaining elevated, Fruhan notes that energy producers are gushing free cash flow. Still, he says, valuations for energy stocks remain reasonable, while the market appears to be debating how long the sector’s recovery can last.

Fruhan believes the answer depends on the duration of the current energy cycle and, of course, the impact of many unknowns. “For example, a recession in the U.S. could lead to a significant decline in demand for energy,” he says. “Yet, on the other hand, if the Chinese economy opens up after several years of COVID-related restrictions, we could see even more demand for energy.”

Energy stocks within the S&P 500^® index, the fund’s benchmark, rose 66% in 2022 before consolidating a bit in early 2023. At the end of January, energy represented more than 13% of the fund’s assets and was the largest sector overweight by a wide margin. Major fund holdings and overweights include Exxon Mobil (XOM), Hess (HES), and Cenovus Energy (CVE).

“Exxon Mobil has benefited from its prior foresight in pursuing capital investments when the price of energy and capital costs were low,” concludes Fruhan of the fund’s top holding. “With these proactive moves, Exxon Mobil has shown itself exceptionally well-positioned for a world of high energy prices and interest rates.”

For specific fund information, including full holdings, please click on the fund trading symbol above.