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In July, the energy sector saw lower prices across nearly all of its commodity groups. Crude oil averaged $87.69 per barrel. Regular retail gas prices fell to $3.44 per gallon. Natural gas prices also continued their descent, averaging 2.91 per MMBtu in July.

As energy commodity prices trend downward, more energy sector companies are finding it difficult to generate revenue and increase profits. The Energy Select Sector SPDR ETF (NYSEARCA:XLE) provides an example of the capital appreciation declines occurring in the energy industry. The ETF is designed to replicate the composition of the S&P 500 Energy Sector.

Year-to-date the XLE reports a gain of 2.11 percent and a one-year return of -6.78 percent. These returns fall significantly below the returns of Exxon Mobil Corporation (NYSE:XOM) and Chevron Corporation (NYSE:CVX), the leading companies in the industry group by market capitalization. On a one-year basis, 60 percent of the companies in the sector portfolio reported negative total return, ranging from -83.8 percent to -2.9 percent.

As the economy recovers at a slow pace and energy prices continue to decrease, profitability in the sector is expected to be gained by companies such as Exxon and Chevron that have sustainable competitive advantages through long-term capital investment and production capabilities.

Exxon Mobil Corporation's most recent earnings report included strong year-over-year gains. In the company's July 26, 2012 earnings call, David Rosenthal, Investor Relations Vice President and Secretary, reported second quarter 2012 earnings of $15.9 billion. Second quarter earnings for the company increased 49 percent from the previous year's $10.7 billion and were $6.5 billion higher than the first quarter of 2012. Year-to-date, XOM's total return ranked 14th in its peer group of 45. On a one-, three-, and five-year basis, the stock has returned 11.67, 9.49, and 2.15 percent, respectively.

Chevron is the second largest company in the industry group by market capitalization at $215.5 billion. The company also recently announced its second quarter earnings, which included strong quarterly growth and a detailed forward-looking production plan that is expected to continue setting it apart from competitors in the industry. Second quarter earnings for the company were $7.2 billion, an increase of $700 million from the first quarter.

For equity investors seeking to capitalize on future growth potential in the energy sector, CVX appears to be the clear industry leader. CVX's returns have been closely aligned with the company's industry growth. Year-to-date the stock has returned 5.46 percent. On a one-, three-, and five-year basis, the stock has been a leader in the industry, returning 7.99, 19.82, and 7.89 percent, respectively. Additional total return information can be found below in Table 1.

As commodity prices remain at their current levels through August and the U.S. economy continues to grow at a slow pace, companies with leading technologies and strong forward-looking production schedules will be the most profitable in the tightening energy sector.

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Source: August Energy Sector Outlook