VDE: Our Top Investment Recommendation For 2021 Reviewed (We Love Energy)

Summary

• Our top 2021 investment recommendation returned 2.5x the S&P 500, as oil prices buoyed energy companies.
• We still see substantial opportunity in the sector, as investors remain fearful of the future.
• We recommend holding onto investments in the Vanguard Energy ETF given its return potential.
• I do much more than just articles at The Energy Forum: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »

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Every year, we consolidate our research for the year into several different investment recommendations, focusing on a number of sectors we cover. One of our most important articles to us, each year, is our "Top Investment Recommendation". For 2021, rather than picking an individual company, we focused on an entire sector (oil).

Since that recommendation, the Vanguard Energy ETF (NYSEARCA:VDE) returned 2.5x the S&P 500 for 2021. The purpose of this article is to discuss why, given the current market metrics, we still love energy.

COVID-19

COVID-19 has been the primary influencer of crude oil prices over the past almost 2 years. Governmental attempts to save lives have resulted in travel lockdowns and restrictions, dramatically reducing oil demand. That reduction in demand, given how volatile crude pricing is, has reverberated throughout the markets.

Global Vaccine Timeline - Statista

Vaccine reluctance is growing in developed countries; however, in less developed countries, the primary issue is lack of supply. The above graph shows when countries expect to have 60% of their population vaccinated and for half the world's population, that's late-2022 onwards. That means the pandemic along with associated lockdowns will be here for a while.

Fortunately, viruses are nifty little buggers. They continuously evolve. It doesn't benefit a virus to kill its host. This is evident through the 'Omicron' variant where indications are that it might be less dangerous than previous variants.

2021 Crude Oil Prices

2021 crude oil prices are the expected significant recovery from the pandemic.

Crude Oil Prices - Bloomberg

From the start of the year, crude oil prices recovered, with some July and August instability, from roughly $50/barrel Brent to more than $85/barrel Brent. That was a substantial 70% recovery going into the end of October. However, at that point, the markets began to respond to what was an expensive market.

First, non-oil exporting nations, already concerned about the effects of such a strong market recovery on inflation, started pushing back. These nations worked together to coordinate a planned release from stockpiles. On top of that, the Omicron variant led to additional lockdowns. That combination helped to place short-term downward pressure on prices.

Since then, prices have begun to recover, and Brent is already back up to >$75/barrel. Given that Omicron no longer appears to be slowing things down, we expect that recovery to continue. OPEC+ seems to be sticking to plans to raise production in line with previous forecasts. That gradual recovery shouldn't put substantial pressure on prices.

Our Forecast

Our forecast is that, at least in the immediate term, oil markets are expected to balance out.

Oil Supply and Demand - IHS Market

The above graph shows oil supply and demand forecasts. The deficit is expected to remain until the end of the year helping to manage the initial massive Covid surplus. On the plus side for a potential surplus, crude stocks remain on the lower end of the historic 5-year range. That could help support the market with the slight surplus expected to develop next year.

In our view, the chance of a major price spike to >$100/barrel is gone. There's no longer going to be a major deficit that could cause that. However, we expect OPEC+ and producers to be cautious and manage prices. As a result, we expect prices to stay in the $70-80/barrel Brent range through 2022. That will be enough to generate profits without overwhelming the market.

We expect volatility to remain in the recovery.

Our Thesis

In our view, with continued volatility, and the potential for a surplus next year, the recovery will be stronger. Producers will be less incentivized to increase production substantially, if at all. Instead, they'll direct cash towards improving their financial positioning and generating more substantial shareholder returns for investors. At $70-80/barrel, profits will remain high.

Those looking to invest don't need to pick a specific company. The Vanguard Energy ETF remains a valuable and top-tier investment for investing in the energy sector.

Thesis Risks

The risk to our thesis is, of course, crude oil prices. A deadlier variant could lead to increased lockdowns. Increases in supply from producers or a faster OPEC+ ramp up could all place pressure on the company. That could hurt the Vanguard Energy ETF, which has already generated strong returns, ability to generate continued shareholder rewards given its higher current valuation.

Conclusion

The Vanguard Energy ETF is up more than 50% YTD. The ETF has a trailing 12-month dividend yield of roughly 3.6% even after that significant growth in valuation. It represents a valuable basket of energy companies that are all significantly undervalued in the current market and generating substantial shareholder profits.

In our view, OPEC+'s continued production increase, combined with Omicron volatility, means it's unlikely for producers to look to increase production. At the same time, with a surplus expected next year, we no longer see the potential for a short-term $100+/barrel spike. However, we still expect prices to remain between $70 and $80/barrel, with volatility managing prices, and enabling strong shareholder returns.

Disclosure: I/we have a beneficial long position in the shares of VDE either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.