Why Every Investor Should Reconsider Their Energy Allocation

Structurally Underweight

Most passive, index-based investors have minimal exposure to the energy sector. As of April 2025, the sector made up just 3.2% of the S&P 500, down significantly from a peak of around 16% in 2008.

Beyond being underrepresented, energy also has a low correlation to the broader market. The Energy Select Sector SPDR ETF (XLE) has a 24-month beta of 0.66, indicating its lower correlation to general equities. The performance of energy companies is directly related to commodity prices. As a result, energy can provide portfolio balance in inflationary or stagflationary environments. We saw this dynamic in 2022 when the sector materially outperformed during a broader equity drawdown.

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Demand is Growing for All Energy Sources

Current valuations may lead one to believe that there is no growth in hydrocarbons and that there is only future demand for renewable energy. However, according to the latest EIA International Energy Outlook, worldwide energy consumption for all sources will continue to increase over the coming decades.

This suggests that all forms of energy are additive and are not zero-sum. This is illustrated over the course of the past several decades by the IEA’s Total Energy Supply by Source in the chart below. Cheap, reliable energy has historically been tied to quality of life, and that relationship is likely to persist.

Renewables: A Role in the Solution

Renewable energy sources such as solar and wind have experienced tremendous growth and will likely continue to do so. However, their inherent intermittency creates a need for stable baseload and peaker power generation. To address this, hydrocarbons, particularly natural gas, have increasingly filled the gap in these applications.

Even though battery storage technologies are rapidly advancing, they still face limitations regarding scale and economic feasibility. Nuclear energy is making a comeback but achieving meaningful scale will require decades of infrastructure investment.

Renewables also lack viable, scalable alternatives for many essential industrial applications including petrochemicals, fertilizers, plastics, and heavy industry. Hydrocarbons are likely to remain in long-term demand for these applications.

Value Proposition of the Energy Sector

There are valid reasons why energy underperformed the broader market for much of the period following the 2008 financial crisis. This era provided a favorable environment for growth stocks with low inflation, low interest rates, and easy money.

At the same time, the U.S. shale boom flooded the market with supply. Many energy companies chased production growth with little regard for capital efficiency, often to the detriment of shareholder returns.

Since 2020, however, the sector has shifted focus. Most companies now emphasize sustainable free cash flow, cleaner balance sheets, and consistent returns of capital through dividends and share repurchases.

The macro environment is also more supportive than it has been in years. Inflation remains sticky, and interest rates are well above levels seen in the decade following the financial crisis. In this backdrop, cash-generating businesses backed by hard assets provide a compelling investment case.

Ways to Play Energy

There are multiple approaches investors can take to gain exposure to the energy sector, each with different levels of risk, income potential, and commodity sensitivity.

Integrated majors like ExxonMobil (XOM), Chevron (CVX), and Shell (SHEL) offer broad diversification across the value chain, from upstream production to downstream refining and marketing. Their size and scale provide stability, and their business models tend to be more resilient through commodity cycles. These companies are often a good fit for conservative investors looking for long-term energy exposure with less volatility.

Exploration and production companies such as ConocoPhillips (COP) and EOG Resources (EOG) provide more direct leverage to commodity prices. They carry higher operational and capital intensity risk, but when paired with quality assets and disciplined management, they can offer strong upside in bullish commodity environments. These names tend to appeal to investors seeking capital appreciation and greater sensitivity to oil and gas pricing.

Midstream and infrastructure companies such as Enbridge (ENB), Enterprise Products Partners (EPD), The Williams Companies (WMB), and Energy Transfer (ET) generally operate on long-term, take-or-pay or fee-based contracts that insulate cash flows from commodity volatility. These businesses are often used as income vehicles, with attractive yields supported by steady cash generation. They may suit investors looking for reliable income with lower commodity risk.

Oilfield services companies represent the most cyclical part of the value chain. There are several subsectors such as integrated services (SLB, BKR), onshore rigs (PTEN), offshore rigs (RIG), completions services (LBRT, ACDC), equipment (NOV, WHD), and compression (AROC, KGS). These names tend to outperform when rig counts and completion activities ramp, but their high operating leverage can quickly turn into a liability during downturns. For that reason, they are best suited for investors comfortable with volatility and looking to express a tactical view on activity levels.

Royalty companies such as Viper Energy (VNOM), PrairieSky Royalty (PREKF), and Black Stone Minerals (BSM) generate revenue through royalty interests without taking on the capital costs or operational risks of drilling. This model provides upside exposure to commodity prices while maintaining strong margins and predictable cash flow. For investors who want commodity leverage with lower execution risk, royalties are worth a closer look.

Renewables, including Brookfield Renewable (BEP/BEPC) and NextEra Energy (NEE), allow investors to participate in the ongoing buildout of clean energy infrastructure. These businesses often trade at premium valuations driven by long-duration growth potential. While near-term returns may be more rate-sensitive, the long-term tailwinds behind decarbonization are expected to remain intact.

Risks

Despite the sector’s improved fundamentals, energy remains inherently cyclical. Commodity prices are volatile, driven by supply-demand dynamics and geopolitics. This volatility can materially impact earnings, particularly for the commodity-exposed integrated majors, E&Ps, oilfield service providers, and royalty companies. Regulatory and policy shifts could increase costs or constrain development. While capital discipline has improved, it’s not guaranteed to hold if prices rise and old habits resurface. Income-oriented names like midstream and renewables may also face valuation pressure if interest rates remain elevated.

Conclusion

Energy is essential, yet remains structurally underrepresented in most portfolios. With improving capital discipline, strong free cash flow, and rising global demand across all energy sources, the sector offers a compelling mix of inflation protection, diversification, and return potential.

In today’s macro environment, businesses backed by hard assets and real cash flows deserve renewed attention. Whether through integrated majors, midstream, E&Ps, services, royalties, or renewables, energy offers multiple entry points for investors willing to look beyond index weightings.