VDE: Ignore The Recent Weakness In Energy

We originally made the Vanguard Energy ETF (NYSEARCA:VDE) our top recommendation for 2021. During that year, the exchange-traded fund (“ETF”) returned 2.5x the S&P 500 (SP500). We finished 2021 by recommending a continued investment in the ETF, which panned out handsomely in 2022. The ETF generated >50% returns in 2022, versus a 19% decline for the S&P 500.

Despite that, and recent weaknesses for the oil markets, we still see the Vanguard Energy ETF as having an ability to outperform.

Oil Price Performance

Oil prices peaked earlier in the year and have continued to drift down ever since then.

Brent crude prices peaked after Russia’s invasion of Ukraine, but since then, they have continued to drift down. This is due to a combination of several factors, including fears of a recession along with Russia’s continued ability to sell its oil internationally. That has pushed Brent crude back down to less than $80 per barrel.

That pressure has hurt the performance of various oil companies.

Vanguard Energy ETF

The Vanguard Energy ETF continues to have a well-diversified portfolio.

The portfolio’s largest holding is a >20% stake in ExxonMobil (XOM) followed by an almost 16% stake in Chevron (CVX). The company’s top 5 holdings have an ownership stake 52% making it a relatively concentrated portfolio. However, all of these investments are strong U.S. energy companies with a strong portfolio of assets.

We’d like to see the ETF diversify internationally, as U.S. energy companies tend to be behind in energy diversification, however, overall the company will reap the rewards of growing energy earnings.

Global Energy Demand

Overall, global energy demand is expected to remain strong.

Climate change is expected to remain a continuing concern. While some companies like ExxonMobil are revamping their portfolios, they’re keeping it a small part of their portfolio. Developed countries are expected to see their energy demand use, but other countries are expecting to increase their demand much faster.

The component oil companies of the Vanguard Energy ETF will need to increasingly diversify and focus on climate change. The U.S. focus of the Vanguard Energy ETF provides strong stability benefits but risks from a shifting energy demand.

Our View

Energy demand is expected to remain strong and while there are downsides to the concentration in the U.S. there are also benefits. Russia and the Middle East, the largest oil and natural gas producing regions in the world, have major systemic risks. As a result, we expect a major move to demand to the U.S. especially on the Gulf Coast and other stable areas.

Overall natural gas and crude oil are expected to remain major sources of demand and the Vanguard Energy ETF is expected to be able to take strong advantage of this. Despite its strong performance recently, the ETF’s companies are heavily focused towards shareholder returns, and many have a double-digit ability to generate shareholder returns.

We expect direct shareholder returns to make the Vanguard Energy ETF a continued valuable investment.

Thesis Risk

The largest risk to our thesis is crude oil prices. We see current prices as low, especially if China changes and reopens its businesses as COVID-19 spreads throughout the country and herd immunity comes through. However, there’s a chance that this won’t happen. There is a chance of a substantial recession, one that could hurt demand and future returns.

Conclusion

The Vanguard Energy ETF had an incredibly strong 2022, supported by our recommendation. The ETF’s component companies are strong U.S. based companies, each that are well positioned to take advantage of a shift in exports away from Russia in particular and in the Middle East as well. At the same time, the companies are backing up investment.

Instead, they have focused on much more direct shareholder returns. They have continued to pay a strong dividend and aggressively repurchase shares. We expect that that will support strong shareholder returns into 2023, especially if oil prices and demand recovers, making the Vanguard Energy ETF a strong investment.