Know Your Energy Companies for Smarter Investing
Oil and gas producers are the best-known type of energy companies, but the energy sector actually consists of various types of companies.
Per the Global Industry Classification Standard (GICS), companies in the energy sector fit into two industries—Energy Equipment & Services, and Oil, Gas & Consumable Fuels. These two industries are further broken into a total of seven sub-industries.
Why Does This Matter?
If you are trying to form a well-diversified portfolio, and you are searching for companies that fit what you are looking for, detailed information about what a company does is more helpful than just a broad description like “energy,” which could mean many different things.
If you bought a stock based only on the sector information, you could end up with a stock that has different catalysts, timing, and risks than you intended.
The Service Companies
The Energy Equipment & Services industry has two sub-industries, Oil & Gas Drilling (GICS code 10101010) and Oil & Gas Equipment & Services (10101020).
The first group consists of drilling contractors such as Nabors (NYSE: NBR), Noble (NYSE: NE), and Transocean (NYSE: RIG). The second group consists of companies that manufacture drilling rigs and equipment and/or provide supplies and services to support exploration and production (E&P) activities. Examples include Schlumberger (NYSE: SLB) and Halliburton (NYSE: HAL).
Thus, both groups are companies. These companies serve the upstream (E&P) companies that actually own and produce the oil and gas. In other words, their fortunes depend on their customers spending money. Thus, their revenues and profits are less directly correlated with oil and gas prices and there’s usually a lag between energy prices and impact on these companies’ finances.
For example, if oil prices go down but E&P companies continue to spend because they see the price drop as temporary, then service companies likely won’t experience much of a dip in business. But if E&P companies tighten their wallets, even if oil and gas prices rise, services companies can have some lean years. In fact, this is what we’ve seen in recent years as capital spending has been down.
The Oil, Gas & Consumable Fuels industry has five sub-industries: Integrated Oil & Gas (10102010), Oil & Gas Exploration & Production (10102020), Oil & Gas Refining & Marketing (10102030), Oil & Gas Storage & Transportation (10102040), and Coal & Consumable Fuel (10102050).
The Integrated Oil & Gas group consists of the vertically integrated companies and Big Oil companies such as Exxon (NYSE: XOM), Chevron (NYSE: CVX), Royal Dutch Shell (NYSE: RDS.B). Besides exploration and production, these companies also do refining, marketing, and other midstream or downstream activities. (As you will see, this sub-industry is basically a combination of the next three sub-industries.) By controlling multiple steps along the supply chain, these integrated companies maintain better control over flow and quality, and if properly operated, they can also lower costs.
Upstream, Downstream, and Midstream
The companies in the Oil & Gas Exploration & Production sub-industry focus on E&P activities. For example, frackers like Anadarko (NYSE: APC) and Apache (NYSE: APA) belong in this group. While producers typically hedge through derivatives to reduce exposure to market price changes, since selling oil and gas is their primary activity, they usually feel the most direct impact of rising or falling energy prices.
Oil & Gas Refining & Marketing typically consists of downstream companies engaged in the refining and marketing of oil, gas, and refined products. Some well-known companies in this corner of the energy market are Valero (NYSE: VLO) and PBF Energy (NYSE: PBF). Refiners can actually benefit when crude oil prices fall. This is because they buy crude and sell refined products like gasoline. The difference between the prices of crude oil and finished products, known as the crack spread, is a critical profitability driver.
Oil & Gas Storage & Transportation companies are largely midstream companies. They transport the oil and gas from production fields and transport and store them until they are processed and refined into consumable forms. You will find companies like Kinder Morgan (NYSE: KMI) and many MLPs in this group.
Many midstream companies generate revenue at least partially via a fixed rate fee based on volume processed (similar to toll collection) so this group offers some protection against oil and gas price decline. However, if prices are bad for long enough to cause upstream companies to reduce activity, then midstream companies will be hurt, too.
The last sub-industry group, Coal & Consumable Fuel, consists of coal miners and companies that produce other types of fuels, such as uranium. Thus, these are not oil and gas companies. Some examples of such companies are Peabody (NYSE: BTU) and Cameco (NYSE: CCJ).
As you can see, under the Energy umbrella, there are different kinds of companies. Understanding the different types can help you better manage your investment portfolio.
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