What Is the Energy Sector?

The Energy Sector Explained

oil rig worker checking equipment
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The energy sector is made up of companies that are highly involved in activities relating to the production, exploration, refining, or transportation of consumable fuels, such as coal, oil, and gas. These companies often engage in activities relating to constructing or providing drilling equipment or oil rigs. They may also handle energy-related services, such as seismic data collection. 

Keep reading for insight into what the energy sector is, how it works, and what individual investors need to know. 

Definition and Examples of the Energy Sector

According to Nashville-based financial advisor and certified financial planner (CFP) Michael Shea, the energy sector is the Global Industry Classification Standard (GICS) for companies that are in the exploration and production, refining and marketing, storage, and transportation of oil, gas, coal, and consumable fuels. The energy sector also includes companies that offer services and equipment, such as oil rigs, to these companies. 

“The S&P 500 Energy index consists of U.S.-based publicly traded companies in the energy sector,” Shea told The Balance over email. “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 explained. The energy sector also includes several different energy sources:

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
  • Increased diversification

  • Large companies

  • Demand

Cons
  • Overconcentration

  • Sustainability

  • Industry threats

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,” Shea said.

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 said. 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 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.

Diversification is important when it comes to building a smart investment portfolio. Consider all different types of sectors, like utilities, real estate, communications, and more, before investing.

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 sector and utilities sector 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.

  Energy Sector   Utilities Sector
Focuses on exploring, producing, refining, marketing, and more of fossil fuels to produce and distribute energy Focuses on providing water, electricity, and other public utilities services to consumers and businesses 
23 companies in S&P 500 Energy index 28 companies in S&P 500 Utilities index

What It Means for Individual Investors

“Individual investors should know that this is only one sector of the market,” Shea said about the energy sector. “They should consider including all publicly traded companies in their portfolio to help with diversification.” 

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 said. “Also, compare the expense ratios of each fund to make sure you are keeping costs low.”

Key Takeaways

  • The energy sector is made up of companies involved in the exploration and production, refining and marketing, storage, and transportation of oil, gas, coal, and consumable fuels. 
  • The energy sector is in high demand and is expected to remain that way for some time. 
  • Diversifying your portfolio is important, so investing only in the energy sector may not be a great idea.

Frequently Asked Questions (FAQs)

What companies make up the energy sector?

The energy sector consists of companies that work with oil, gas, coal, and other fields in some way. There is no hard-and-fast number as companies may fold over time, while others start up and grow. In terms of investing in the energy sector, it depends on the index. For example, 23 companies make up the S&P 500 Energy index. This number varies across indexes.

How are electric vehicles impacting the energy sector?

Electric vehicles may be seen as a threat to the energy sector because they don’t require fuels like oil and gas that energy sector companies work with. This could make investing in those companies less desirable to investors. Some car manufacturers, for example, have started to increase electric car production. General Motors has pledged to go completely electric by 2035.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.