“The S&P 500 Energy index consists of U.S.-based publicly traded companies in the energy sector,” Shea explains. “Approximately 23 companies make up this index, which you can access through index funds or [through] buying the stocks individually.”
How the Energy Sector Works
The energy sector tracks individual companies in the energy business, as well as the overall energy industry, Shea explains. The energy sector also includes several different energy sources:
Natural gas Electricity Petroleum Renewable sources Coal and coal coke
All industries use energy, but three in particular consume the majority of the U.S. industrial sector’s energy: bulk chemical, refining, and mining.
Pros and Cons of the Energy Sector
Pros Explained
Increased Diversification
You can add the energy sector to your investment portfolio through energy exchange-traded funds (ETFs), the S&P 500 Energy index fund, or even buying shares of particular energy stocks. Know your risk tolerance first though. “It can be beneficial to buy the entire index through an ETF, for example, because you are buying a basket of companies instead of individual stocks, which could be more volatile in nature,” says Shea.
Large Companies
“The major players in the energy sector are massive companies that have been in business for a long time, and these companies are valued well into the billions, making them some of the largest companies in the world,” Shea says. These companies may be less likely to go bankrupt in comparison to smaller startup companies, though this is not guaranteed.
Demand
According to Shea, the industry will likely be in high demand for a long period of time even with disruption from technological advances. Large energy companies have big pockets and are at an advantage to be able to pivot and reinvest into new markets as they emerge. This makes them adaptable to changes in the industry and economic environment.
Cons Explained
Overconcentration
The energy sector is only one piece of the overall stock market. According to Shea, there are a couple of indexes that give you broader exposure to the energy sector. But when you look at the number of companies in those underlying indexes, there are only a handful of companies. The point is that this is a small portion of the overall market, which could overconcentrate your portfolio if this is the only sector that you invest in.
Sustainability
Investors are starting to take interest in environmental, social, and governance (ESG) criteria when investing. “The goal is to drive more investment into green companies to make a positive impact on the environment,” Shea said. “These investments may specifically exclude traditional energy-type companies, taking market share away from the energy sector.”
Industry Threats
The energy industry is facing disruption with the production of electric cars and policymakers incentivizing manufacturers and consumers to purchase them. Shea said he worries this will put pressure on the energy sector since people may end up relying less and less on oil and gas. Government regulations and trade tariffs can be difficult to navigate or control, which can cause issues with increased expenses and supply chains, making it more difficult and costly to distribute globally. All of this could affect investors who put money into the energy sector.
Energy Sector vs. Utilities Sector
The main difference between the energy and utilities sectors is the types of companies in each sector. Each index has its own methodology for constructing the sector and which companies are included. For example, the S&P 500 Utilities index includes 28 U.S. companies that are in the S&P 500 and are classified as utilities per the GICS. The utilities sector is made up of utility companies relating to electric, gas, and water. It also includes independent power producers and energy traders, as well as companies that engage in the generation and distribution of electricity using renewable sources. Utility companies are different from energy sector companies because they are focused on providing services to consumers and businesses, such as electricity, water, and other public utilities. The energy sector focuses more on finding and using fossil fuels to produce and distribute energy. According to Shea, there are various index funds that allow you to invest in the energy sector. “I’d recommend doing your research on the underlying holdings of each index fund to see how the funds are being allocated and which companies are included in the portfolio,” Shea says. “Also, compare the expense ratios of each fund to make sure you are keeping costs low.”
