Industry Analysis - Energy Sector

Industry Analysis - Energy

There is no doubt that the energy industry extremely large, representing 11.07% of the S&P 500. Some key ratios for measuring profitability in the industry are Gross Profit Margin (69.27%), ROE (7.52%), and ROA (3.73%). Also, some common ratios used for placing a value on a company in the industry are the P/E (27.32) and P/B (2.58) ratios. The energy industry is made up of many sectors, but can be broken down into three primary sectors: crude oil, natural gas, and refining margins.

Crude Oil:

Due to the extremely high prices of crude oil, there has been an increase in the supply of natural gas as well as refining capacity. Crude oil production remains stagnant with a 1% CAGR, which tells us that the era of accessible, low-cost supply could potentially come to an end, which would force the prices of natural gas upwards. The rate of US oil production decline is slowing for the first time in 33 years because of shale and other and other resource plays. Enhanced drilling and completion methods will likely be extrapolated to other US regions and countries abroad.

Natural Gas:

Natural gas prices are extremely low and are likely to be pressured lower until prices reach cash operating expenses. Low natural gas prices and decreased cash flow from gas production has not slowed the pace of development. With more than $27 billion of acquisitions and joint ventures from larger, better-capitalized companies, drilling continues from independent producers as companies satisfy drilling commitments. The ability to develop large reserves of natural gas with horizontal drilling and improved completion techniques has changed the game of natural gas in North America. Companies that have gone to producing shale gas possess low-cost resource basins and have an advantage over their competition that lack low-cost supply. The last four times the natural gas prices fell this low, in the subsequent 6 to 12 months, the prices for natural gas rose 44% and the underlying equities gained 68%, outperforming the market by 47 percentage points on average.

Integrated Oils:

Integrated oils are the largest component within the energy sector. This sector is made up of large diversified multinational companies that explore for oil and natural gas in the most remote and undeveloped regions across the globe. Combined with their refining and marketing operations, earnings and cash flow tend to be more stable than their independent E&P and R&M competitors. These companies deploy capital into projects that span 25 to 30 years, so capital allocation and returns are often the highest.

As for future expectations with a 30-year time horizon, we see energy being used more efficiently and energy supplies continuing to diversify as new technologies and sources