Energy market commentary

Energy market commentary: July 2021

Capital discipline today could set up energy producers for solid cash flow in the future.

August 4, 2021 | 5 minute read

Data as of July 31, 2021, unless otherwise noted.

Performance (total returns)

BenchmarksJuly 2021YTD
Alerian MLP Index (AMZX)-6.31%38.51%
Alerian Midstream Energy Select Index (AMEIX)-3.69%37.49%
ICE BofAML U.S. High Yield Energy Index (HY Energy)-0.17%10.02%
S&P 500 Energy Index (S&P Energy)-8.27%33.60%

Performance data quoted represents past performance and is no guarantee of future results. An investment cannot be made directly in an index.

Energy decline after record first half: Energy stocks retreated following their best-ever first half as the spread of the delta variant brought demand concerns back to the fore. S&P Energy declined -8.27% in July, its worst month since September 2020, although energy remains the top-performing sector in the S&P 500 YTD. The AMZX and AMEIX fell -6.31% and -3.69%, respectively, in July, as midstream continues to take its cue from the broader energy sector in 2021. HY Energy bonds were essentially flat on the month, as the income return mitigated a modest widening in spreads. WTI crude prices closed at a new 3-year high of $73.95/bbl and rose above $75/bbl intramonth for the first time since 2018. The market was whipsawed mid-month as a rift developed within OPEC+ around the pace of production increases. In the end, the issue was resolved and OPEC+ still plans to return trimmed supply to the market at a gradual pace. For now, the largest risk for the oil market appears to be rising COVID cases across many parts of the world.

Money is flowing into the energy sectorHalfway through 2021, flows into U.S. energy funds suggest the sector is receiving a level of attention from investors that it has not seen in at least a decade. According to Morningstar, mutual funds and ETFs focused on the U.S. energy sector took in $12.6 billion of net inflows from December 2020 through May 2021, the highest 6-month total over the last 10 years. Certainly, the strong returns of the energy sector—including a 45.64% YTD return, far and away the top sector in the S&P 500—are a major factor in luring investors. However, there are other factors at play. With inflation seen as a key risk for markets, energy stocks can act as a sort of hedge via their exposure to commodity prices. The strong performance of energy stocks has also shone a bright light on the reality that many investors are severely under-allocated to the sector compared to history. Years of poor performance has taken energy’s weighting in the S&P 500 from over 12% a decade ago to less than 3% today, and thus investors in passive index funds hold very little exposure to energy names. Interestingly, it has not been solely funds focused on oil and gas companies that have attracted capital this year. While they have seen the majority of inflows, the three largest U.S. clean energy-focused ETFs have taken in $5.6 billion so far in 2021, roughly equaling the amount flowing into the largest S&P Energy-tracking ETF. It has been years since sentiment in the energy sector has been this positive, and investors clearly want exposure to both traditional fossil fuel companies and renewables.

Key takeaways

  • The first half of 2021 was the best-ever for energy equities.
  • Capital discipline today could set up energy producers for solid cash flow in the future.

Index descriptions: Alerian MLP Index is the leading gauge of energy Master Limited Partnerships (MLPs) and is a float-adjusted, capitalization-weighted index, whose constituents represent approximately 85% of total float-adjusted market capitalization. Alerian Midstream Energy Select Index is a composite of North American energy infrastructure companies and is a capped, float-adjusted, capitalization-weighted index, whose constituents are engaged in midstream activities involving energy commodities. ICE BofAML U.S. High Yield Energy Index is designed to track the performance of U.S. dollar-denominated high yield rated corporate debt publicly issued in the U.S. domestic energy market. S&P 500 Energy Index comprises those companies included in the S&P 500 that are classified as members of the Global Industry Classification Standard (GICS) energy sector.

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This energy market commentary and any accompanying data is for informational purposes only and shall not be considered an investment recommendation or promotion of FS Investments or any FS Investments fund. The energy market commentary is subject to change at any time based on market or other conditions, and FS Investments and FS Investment Solutions, LLC disclaim any responsibility to update such energy market commentary. The energy market commentary should not be relied on as investment advice, and because investment decisions for the FS Investments funds are based on numerous factors, may not be relied on as an indication of the investment intent of any FS Investments fund. None of FS Investments, its funds, FS Investment Solutions, LLC or their respective affiliates can be held responsible for any direct or incidental loss incurred as a result of any reliance on the energy market commentary or other opinions expressed therein. Any discussion of past performance should not be used as an indicator of future results.

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