The Substantiality Of Investment In Energy Stocks

This story features WOODSIDE ENERGY GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: WDS

One of the remarkable events that occurred in 2022 is the de-coupling between share prices of energy producers worldwide and the price of crude oil, as also shown in the graphic below.

This de-coupling has turned the energy sector globally into a de facto safe haven as most risk assets experienced elevated turmoil while going through a painful de-rating process, including the price of oil.

Parts of the investment community believe oil producers, and potentially the energy sector in a broader sense (incl nat gas and thermal coal), can continue to act like a haven next year even with economic recessions potentially hitting economies in the UK, continental Europe, the US, and elsewhere.

The story below reflects this view.

The Substantiality of Investment in Australian Energy Stocks

-Capital preservation has become vital for investors faced with ongoing macroeconomic adversities
-Energy stocks globally turned into a safe haven in 2022
–Australian energy stocks look poised to continue to provide favourable performance for investors

By Anuj Sharma

Central banks have signalled more rate hikes and sustainability of rates at higher levels, breeding fear of economic recessions in 2023.

Energy stocks are among those securities that protected investors' capital and delivered price growth against market trends throughout the year past. 

During the first half of 2022, when major sectors in the global stock market were experiencing significant adversities with share prices sinking, most of the leaders in the Australian energy sector were proliferating in terms of price growth showing decisive outperformance over benchmark indices.

Mayhem in Global Financial Markets

A prolonged tightening of monetary conditions withdraws liquidity from the financial systems, enhancing the risks of economic growth stagnation.

On the other hand, strengthening the US dollar is concentrating the global capital flow towards the US and shifting economic stress and inflation to other advanced economies.

Liquidity deficiency in equity markets enhances risk aversion among investors, impacts stock price volatility, and reduces trading volumes, especially on the buy side. 

Levels of leading economic indices indicate significant weakness is ahead for the US, European, and Chinese economies, whereas, in Australia, expected economic conditions are comparatively stronger.

Performance of Australian Energy Stocks

Higher energy prices, with the increasing efficiency of energy producers in extracting and processing energy minerals, lead to expanded profit margins and free cash flows. The financial outperformance is integrated by the efficient market, which is reflected in market valuations of Australian energy companies.

The basis of the outperformance of energy stocks is directly related to instability in the global economy and the slower pace of technological emergence. Soaring commodity prices, based on less availability of energy minerals, deterioration of global trade, and covid pandemic shocks on economic activities, are breeding higher energy prices ontologically. 

As of November 22, 2022, the ASX200 Energy index shows a remarkable year-to-date (YTD) gain of nearly 47%. Over the same period, the domestic benchmark ASX200 has delivered a negative -4% return, while the S&P500 in the US retreated by -17%.

Woodside Energy ((WDS)), the local sector leader, has delivered a 73% return. YTD returns generated by some of the sector participants have reached (much) higher levels, including for Whitehaven Coal ((WHC)) 230%, New Hope Corp ((NHC)) 151%, Stanmore Resources ((SMR)) 144%, and Yancoal Australia ((YAL)) 96%. 

Whether energy stocks will continue their 2022 outperformance into 2023 is a critical question for investors. The most vital fundamentals supporting the performance of Australian energy stocks include the following: 

-Ongoing energy crisis in Europe after the Russian energy blockade. Major European countries depend on coal, hydropower, and nuclear energy (solar and wind to some extent). The EU’s current energy policy is weak in ensuring energy security for the region over the long-term.

-The United States is producing and exporting oil and gas at the maximum infrastructural capacity. Still, there is a significant capital investment in motion, but American energy will not have the ability to replace Russian global energy exports. 

-Canada is producing more oil and gas than domestic demand to export all the remainder to one customer, the US.

-OPEC is deviating from the US objective to balance the energy market to neutralise the Russian energy effect. Instead, OPEC is destabilising the global energy market by instrumentalising its energy output to preserve its strategic significance. 

These factors create a broad scope and prolonged opportunity for Australian energy that is readily available and cost-effective for emerging countries and the EU. 

After the onset of the pandemic, growth in Australian exports has become aggressive. Energy companies expect significant earnings growth in 2022 from the ongoing supply-demand imbalance in the global energy market that is expected to continue through 2023.

Intensifying Global Energy Crisis 

The global crisis is delivering inflationary pressures on the economy and breeding the risk of recession.

The boosted energy prices have generated nearly US$2trn over 2021’s earnings for energy producers (fossil fuel). Energy markets are now extremely sensitive to macroeconomic changes.

A new wave of geopolitical turmoil, supply shocks, or escalation of war (especially sanctions and financing restrictions) can ignite a drastic supply-side shift that can have a prolonged effect on energy prices into the future. 

Technical limitations

If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

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