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Energy Sees Boost in Second Quarter

But first-quarter wallop still stings.

Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

David Meats: The outlook brightened for energy stocks in the second quarter, Morningstar's US Energy Index gained 28% as at the end of March, as compared with a gain of 18% for the Broader US Market Index. And oil prices essentially doubled in the same period. But by and large, the energy sector still looks cheap even after this rally. On supply side, OPEC and its partners have U-turned after kicking off a price war back in March and have now pledged substantial production cuts, collectively withholding almost 10 million barrels a day from the market.

Compliance with those cuts isn't perfect, but the initiative still makes a big difference and should help rightsize crude inventories over time. And on the demand side, we think reduced social distancing, combined with unprecedented fiscal stimulus, should support further recovery. So the U.S. shale industry will remain a key component of the global crude supply stack, and the shale business model doesn't work at current oil prices. We think prices must recover to incentivize producers to keep drilling. 

As a result, we see value across the entire energy complex, but the most undervalued sector is oilfield services. Upstream firms will have to increase capital spending in the next few years to offset worldwide production declines, and the market isn't giving all food-service stocks enough credit for that. Our top pick is Schlumberger, which has a 5-star rating and a narrow moat.

Dave Meats does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.