Fidelity Select Energy Portfolio Q3 2024 Review (FSENX)

PERFORMANCE SUMMARY

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Market Review

The energy sector, as measured by the MSCI U.S. IMI Energy 25/50 Index, returned -3.21% in Q3, versus 5.89% for the broad-based S&P 500^® index. (SP500, SPX) The broad-market index benefited from resilient corporate profits, the promise of artificial intelligence and the U.S. Federal Reserve’s long-anticipated pivot to cutting interest rates. Amid this favorable backdrop for higher-risk assets, the S&P 500 continued its late-2023 momentum and ended September at its all-time closing high. Value stocks led the way, while smaller-cap shares outpaced large-caps in what was a broad rally, with eight of 11 sectors outpacing the market.

The shift toward global monetary easing gained steam when the Fed lowered its benchmark federal funds rate after a historic hiking cycle that began in March 2022 to combat persistently high inflation. On September 18, the central bank cut rates by 0.50 percentage points, opting for a bolder start in making its first rate reduction since March 2020.

Against this backdrop, energy stocks lagged the broader market amid declining crude-oil prices, which often influence corporate profitability among energy companies. The price of West Texas Intermediate crude oil declined about 17% in Q3, falling to roughly $68 per barrel, from about $81 bbl at midyear. Meanwhile, Henry Hub natural gas prices remained range-bound in Q1, between $2.00 and $2.50 per Metric Million British Thermal Unit. The price of this commodity remained historically low, however, which continued to be somewhat of a headwind to profit growth for natural gas-related businesses.

Among the larger industries within the MSCI sector index, integrated oil & gas storage & transportation, which represented about 38% of the sector index, returned -1%. In this group, Chevron (CVX, -5%) and Occidental Petroleum (OXY, -18%) were notable laggards. The oil & gas exploration & production industry (-7%), which comprised about 27% of the index, also underperformed. Here, Canadian Natural Resources (CNQ, -6%) and ConocoPhillips (COP, -7%) stood out to the downside. Conversely, the oil & gas storage and transportation segment gained about 8% in Q3, led by ONEOK (OKE) and Kinder Morgan (KMI, +13% each).

Performance Review

For the third quarter, the fund had a return of -5.13%, trailing the MSCI U.S. IMI Energy 25/50 Index and the broad-based S&P 500 index.

Stock choices in the integrated oil & gas category detracted from the fund’s performance versus the sector index this quarter, as did investments in oil & gas exploration & production.

An out-of-index stake in Cenovus Energy (CVE, -14%) was the fund’s biggest individual relative detractor. In early August, the integrated oil & natural gas company reported second-quarter earnings that missed analysts’ consensus expectation. Management cited a lower-than-expected profit margin in its Canadian refining business due to higher costs and weather delays. Despite that, the company announced it achieved its $4 billion target for net debt in July and released a favorable 2024 guidance update. We largely maintained our position in Cenovus, which was the fund’s second-largest holding and biggest overweight as of quarter end.

Conversely, a non-index stake in Texas-based independent power producer Vistra (VST, +38%) contributed most. On August 8, the company reported better-than-expected second-quarter financial results, driven largely by its retail business and strong synergies from its recent acquisition of Energy Harbor (OTC:ENGH). The deal allows the company to accelerate the growth of its zero-carbon operations and add about one million retail customers. Vistra affirmed its financial guidance for the remainder of 2024 and said it remains in discussions about the development of new data centers. Nuclear power-related stocks, including Vistra, surged even further in September on news that the Three Mile Island nuclear site will go back into service in 2028. As such, we increased the fund’s stake in Vistra the past three months.

LARGEST CONTRIBUTORS VS. BENCHMARK

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LARGEST DETRACTORS VS. BENCHMARK

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Outlook and Positioning

As of September 30, we expect oil prices to remain healthy and conducive to energy companies’ corporate profitability – likely in the $70 to $90 per barrel range − barring any major changes in the environment, such as a global recession. Looking ahead, the key drivers of oil prices include rising global demand, slowing U.S. supply growth as shale drilling matures, production restraint by the Organization of the Petroleum Exporting Countries as key member Saudi Arabia seeks to maintain high oil prices, and elevated geopolitical risk due to ongoing wars in the Middle East and Ukraine.

Meanwhile, U.S. natural gas prices are likely to remain under pressure due to healthy domestic production, further delays in the development of U.S. LNG export terminals and modest growth in demand in this country. Generally speaking, industry refining margins are a bit of a wildcard due to the uncertain timing of new capacity additions, offset by refinery retirements in the U.S. and Europe. However, we believe U.S. refining margins should remain structurally higher than historical levels due to low U.S. natural gas prices and crude-oil costs relative to non-U.S. refiners.

The risk of increasing geopolitical tension in the Middle East could lead to rising prices for oil and gas, especially if production from key producers, such as Iran, Saudi Arabia, UAE, Qatar or Iraq, is disrupted by regional security issues.

Weakening global economic growth, particularly in either the U.S. and/or China, could lead to slowing demand for oil and natural gas. Longer term, however, we’ll note that increasing investments will be needed to meet what we believe will be rising demand for oil and gas in the coming years and decades. Elsewhere, rising demand for electricity related to reshoring, electrification trends and the buildout of new data centers should be an important trend in the power industry, with some spillover to natural gas markets over time.

As of September 30, the fund’s most prominent industry overweight is among integrated oil and gas stocks, with a large out-of-index stake in Cenovus Energy and an overweight in Exxon Mobil (XOM) – the fund’s two largest holdings. The fund also is notably overweight energy equipment & services stocks because we believe the outlook for capital spending in this segment is poised to improve. This is an industry that we believe should benefit from multiple years of growing investments needed to support rising demand for oil and gas. We believe many investors are underestimating the need to meet the world’s growing demand for oil and gas, as well as the upside of the upcoming business cycle for oilfield services firms. Moreover, there have been several years of low investment in global markets, which recently has reversed course. Among the fund’s biggest individual overweight positions in this group as of quarter end are TechnipFMC (FTI) and SLB.