Morningstar - Q1 2021 - 66

Investors

Not Dead Yet
The flagging energy sector isn't down
for good.

SECTOR RAP

Laura Lallos

No sector has been harder hit by the pandemic
than energy. While the broad stock market
has recovered, energy stocks remained deeply
undervalued relative to Morningstar's fair
value estimates in December. With crude-oil
demand down precipitously and renewable energy
use on the rise, even value hounds might
hesitate here.
David Meats, who leads Morningstar's energy and
utilities equity coverage, says that traditional
energy companies aren't dead yet. That said, it is
important to choose carefully. We spoke on
Nov. 10, and the conversation reflects performance
and valuations as of that date.
Laura Lallos: Why is the energy sector so
deeply discounted?
David Meats is director of equity
research, energy and utilities,
with Morningstar Research
Services LLC.

Meats: Don't forget that energy was one of
the more unloved sectors before we even got to
the pandemic. The market has lost a lot of
confidence in the wider energy industry for various
reasons over the past several years. If you
go back 10 years or so, energy was about 13% of
the S&P 500, and today it's well under 5%.

Then, due to the impact of the pandemic,
with widespread stay-at-home orders and curtailed
travel all over the world, oil demand quickly
collapsed by about 8 million barrels a day, on

66

Morningstar Q1 2021

average, over the year in 2020. That's about
8% of global demand. That is a substantially larger
drop than we've ever seen before, even if
you go back to oil shocks of the 1970s and '80s.
This is a whole new breed of downturn
that's created a very difficult environment for
the oil industry.

be permitted to work from home because of
productivity and efficiency concerns. In finance,
performance can be benchmarked easily,
but in other industries, that's not the case.
Of this 20% of workers who are permitted to
work from home, we think only two thirds would
choose to. Not everyone wants to work at
the kitchen table with pets and kids, unconnected
to coworkers. That means only 13% of workers
are eligible to work from home, would be
permitted to do so, and would choose to do so
permanently-compared with 9% back in
2019. As commuting is only about 8% of global oil
demand, the total impact on demand would
be much less than 1% in the long run.
Lallos: What other concerns have been holding

the sector down?
Lallos: Energy did surge when Pfizer PFE announced

its vaccine, more so than the market overall.

Meats: It's very telling that even the mere
possibility of a vaccine was enough to drive up
crude prices by 8% on Nov. 9 and to drive
up some of the more leveraged oil stocks by about
20% on average. There had been a concern
in the marketplace that even if the COVID-19
pandemic was behind us, the energy sector might
still be left for dead. As we get closer to
back to normal with the way that we live, work,
and travel, that will flow through to the
consumption of transport fuels, which is the
ultimate driver of crude demand.

We don't think the consumption of crude will
be permanently impaired by the pandemic.
Some folks expect a permanent shift to working
from home that would upend crude markets.
We don't subscribe to that theory. In 2019, 9%
of U.S. workers were working remotely.
In 2020, that number was close to 45% at the
peak, back in April. That's a big shift, but
how sticky is it?
Working from home isn't for everyone. If you
work in finance, you can fire up Excel at your
kitchen table, but if you work in retail or mining or
construction, then you don't have that option.
We estimate that only 40% of total workers are in
an occupation that's eligible for working from
home. Of that 40%, we think that only half would

Meats: Another concern that I hear is that we're
all going to be driving around in electric
vehicles very soon, particularly after the election
of a Democratic president. We do think that
gasoline consumption will eventually decline. In
some developed economies, it is already near
a peak. But oil is a global commodity. Even
if countries like the United States see demand
declines in the near future, there are large
emerging economies that are still growing their
gasoline consumption, such as China
and India.

The emerging middle class in China means many
people are buying a vehicle for the first time.
Even if half of them are electric, that means half
of them aren't. The other thing that people forget
is that a vehicle has an average life of 15 to
20 years. Even if electric vehicles reached a very
high sales penetration very quickly-it's
around 2% currently-there'd still be 20 years
before all of the internal combustion engines on
the road disappear.
What drives gasoline demand is not the fuel
efficiency of the vehicles being sold in any given
year; it's the fuel efficiency of the vehicles
on the road. While fossil fuels will decline in the
transport mix, folks are overestimating how quickly
that will happen. We think that global crude
demand will rebound in the next couple of years
and stay fairly flat for several years after
Morningstar - Q1 2021

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