2023 Spotlight on Energy
From the potential for recession to war in Ukraine, there’s a lot that could impact Energy in 2023. Baird’s Global Energy Team asked Strategas’ research and policy experts for their thoughts on the current state of the sector and what they’re keeping an eye on for the remainder of the year.
Where We Are Now
The Energy sector was the S&P 500’s bright spot in 2022: While the broad index was down nearly 20%, its Energy stocks showed a record gain of 58% over the previous year. But even though this sector was the S&P 500’s lone winner in 2022, and despite two years of stellar performance, Energy enters 2023 somewhat undervalued by investors. Consider these markers of its recent strength:
- While the Energy sector makes up only 5% of the S&P 500’s market cap, it has accounted for 12% of its earnings. (By comparison, the Technology sector is showing only 21% in earnings despite accounting for more than 26% of the index.) No other sector is punching up close to this degree.
- Exxon Mobil is leading the charge: Of the S&P 500’s 50 largest stocks, XOM is closest to its 52-week high.
- It’s not just the big names in Energy whose stocks are performing well. We’ve seen positive momentum throughout the pipeline, including in refinery (such as Valero Energy Corporation) and exploration & production (such as Hess Corporation).
S&P 500 Earnings Weight & Sector Weight Differential
| Sector | Earnings Weight | Sector Weight | Differential (Sorted) |
| Energy | 12.4% | 5.2% | 7.2% |
| Communications | 9.4% | 7.8% | 1.6% |
| Financials | 13.1% | 11.63% | 1.5% |
| Materials | 3.5% | 2.8% | 0.7% |
| Health Care | 15.4% | 15.1% | 0.3% |
| Industrials | 8.2% | 8.4% | -0.2% |
| Utilities | 2.7% | 3.0% | -0.4% |
| Staples | 5.7% | 6.8% | -1.0% |
| Real Estate | 1.6% | 2.8% | -1.1% |
| Discretionary | 6.7% | 10.2% | -3.5% |
| Technology | 21.4% | 26.3% | -4.8% |
The 7.2% gap between Energy’s sector weight and earnings weight is the largest in the S&P 500. As of 1/30/2023.
Where We Are Headed
One of the biggest questions headed into 2023, both for Energy and the broader U.S. economy, is the potential for a recession. While it’s too soon to say for sure, there are indicators that some degree of contraction is forthcoming, such as the inversion of the two-year/10-year Treasury yield curve or January’s New York state factory index reading of -32.9. (This index measures factory activity and order demand for the state. A reading below zero is a sign that the state’s manufacturing sector is contracting – and this reading is the fifth-worst in the survey’s history.)
Historically (though not without exceptions), the Energy sector has tended to lose ground in recessionary environments. For example, the past three recessions have seen a significant decrease in the country’s energy consumption:
During times of recession (grey bars), consumer energy consumption and demand tend to decrease – sometimes dramatically.
Recent stock market history also gives us pause when considering Energy’s outlook. The Energy sector has more than doubled its weight in the S&P 500, having grown from composing 2% of the index in 2020 to 5% to close out 2022. That is a rare and impressive feat, having occurred only four other times in the past 45 years. In each of those times, though, those sectors that have doubled their S&P 500 weight over two years have seen further index growth pause or retreat in the 2–3 years following. It’s a small sample size, but something worth keeping an eye on.
What Else We’re Watching
Beyond the potential for recession and its ramifications, here’s what else we’re looking at as the year unfolds:
- Capital spending in Energy. Every quarter the Dallas Fed surveys executives from oil and gas firms regarding their capital spending plans and general business outlook. Seventy-five percent of respondents to the most recent survey reported that they do not intend to grow their capital expenses meaningfully from 2022 levels, which is consistent with the sector trend of returning capital to shareholders instead of ramping up production. It looks like the bulk of the actual rise in capital expenses will come from higher labor costs instead of new drilling or production growth.
- The reopening of China. China has essentially acknowledged its zero-COVID policy was ineffective and unsustainable. We expect the country to ultimately resume its traditional pro-growth trajectory, which would result in a potentially dramatic increase in global demand. In its January Oil Market Report, the International Energy Agency projects global oil demand to rise to a record 101.7 mb/d in 2023, with nearly half the gains resulting from China lifting its COVID restrictions.
Over the past 25 years, global energy demand broadly has been increasing.
- Slowing the brakes on renewable energy. While much has been made about legislation concerning renewable energy and transitioning away from fossil fuels, it’s worth noting that consumption of coal reached an all-time high in 2022. As we near the one-year anniversary of Russia’s invasion of Ukraine, and with no end in sight, it would not be a surprise to see policymakers in Europe expand their definition of “green” energy initiatives to include nuclear and natural gas projects.
A Final Thought on Recession and Inflation
Threading the needle for a soft landing, while difficult, is not out of the question: There is still excess U.S. cash savings left over from the fiscal stimulus, it’s possible that the Fed’s rate hikes can eliminate job openings before eliminating too many jobs, and perhaps China’s potential reopening could lead to global growth later in 2023. It’s too soon to say for sure.
Another important point to remember: It’s not enough to lower inflation – we expect the Fed to focus on how to keep it from bouncing back. History warns us to avoid the “stop-and-go” mistakes of the 1970s, when twice inflation roared back after it was thought to be beaten. This alternate approach of “hike-and-hold” will require maintaining a more restrictive environment over time, keeping interest rates elevated for longer than many might expect. We’re keenly watching how this will impact Energy.
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