Investing in Energy Stocks

The energy sector is vital to the global economy. It produces and supplies the fuels and electricity needed to keep the economy humming. The energy industry includes companies involved in the following activities:

• Renewable energy stocks: These companies manufacture components to produce electricity using renewable resources such as solar, wind, hydroelectric, and geothermal power. They also include companies that operate and develop renewable energy-generating facilities.
  • Solar energy stocks: This subgroup of renewable energy focuses on manufacturing solar panels and components to generate electricity from the sun.
  • Wind energy stocks: This subgroup focuses on manufacturing wind turbines and blades.
• Oil and gas stocks: These companies focus on finding, producing, transporting, storing, refining, and exporting fossil fuels.
  • Oil stocks: Oil companies focus on finding, producing, transporting, and refining crude oil.
  • Natural gas stocks: Natural gas companies concentrate on finding, producing, transporting, and exporting natural gas.
  • Liquefied natural gas stocks: Liquefied natural gas (LNG) companies develop and operate facilities to liquefy natural gas.
• Utility stocks: These companies generate and distribute electricity and natural gas to customers.
  • Electric utility stocks: Electric utility companies generate and distribute electricity to customers.

This broad industry is crucial to providing the economy with the energy it needs. It's also an important one for investors to understand.

Energy sector stocks to buy

Hundreds of public companies focus on the production and distribution of energy. However, a few leaders stand out because of their size and financial strength. Here are five of the best energy stocks to consider buying in 2022:

Here’s a closer look at some of the best energy stocks in the industry.

Brookfield Renewable

Brookfield Renewable is a leading global renewable energy producer. It operates hydroelectric, solar, wind, and energy transition assets. The company sells the power these assets produce under long-term fixed rate power purchase agreements (PPAs) to electric utilities and other large power users.

Those contracts enable Brookfield to generate relatively steady cash flows, which mostly are used to pay an attractive dividend. The company retains the rest to acquire, develop and expand its renewable energy operations.

The company has an enormous backlog of renewable energy development projects. Combined with other growth drivers like acquisitions and higher power prices, Brookfield expects to grow its cash flow per share by as much as 20% annually through 2026, supporting a 5% to 9% yearly dividend growth and making Brookfield an excellent way to invest in renewable energy.

ConocoPhillips

ConocoPhillips is a diversified oil and natural gas producer. It has operations around the world and uses several methods to produce oil and natural gas.

ConocoPhillips stands out for its low operating costs. It has an average cost of supply of less than $30 a barrel. ConocoPhillips complements its low cost of supply with a strong balance sheet. It has an investment-grade bond rating backed by a low leverage ratio. That provides it with plenty of cushion to weather frequent periods of low oil and gas prices.

ConocoPhillips’ low operating costs position it to generate significant cash flow in the coming years. The oil and natural gas company estimates it can produce a cumulative $80 billion in free cash flow by 2031. That assumes oil prices average $50 per barrel. With oil prices entering 2022 well in excess of that price point, ConocoPhillips should generate a gusher of free cash flow.

The company anticipates returning almost all of that windfall to investors in the coming years. It plans to repurchase shares, pay a growing quarterly dividend, and make variable return of cash payments (an incremental dividend payment from its excess cash) as it generates excess cash due to higher oil prices.

Chevron

Chevron is a leading global energy company. It boasts a globally integrated oil and gas business that includes exploration and production assets, refining capabilities, and a chemicals business. The company’s large scale and integrated operations helps it weather the volatility in the energy sector.

Chevron uses the cash flows generated from its legacy oil and gas operations to pay a growing dividend, repurchase shares, and invest in the future. Chevron increased its dividend for the 35th straight year in 2022, which means it more than qualifies as a Dividend Aristocrat.

Part of Chevron’s investments in the future is its goal of reducing its carbon emissions. The company is investing in carbon capture and storage technology. In addition, it agreed to acquire Renewable Energy Group (NASDAQ:REGI) in 2022 for more than $3.15 billion. That deal will accelerate Chevron’s ability to achieve its goal of growing its renewable fuels production capacity to 100,000 barrels per day by 2030.

Overall, Chevron aims to supply the fuels the economy needs today while building towards the lower-carbon fuels it requires in the future. That balance makes it an ideal choice for investors seeking a way to invest in the energy transition from fossil fuels to cleaner alternatives.

NextEra Energy

NextEra Energy is one of the country's largest electric utility companies. It's also a global leader in producing power from the wind and sun through its energy resources segment, which sells clean energy to other utilities and end users around the country.

The business generates relatively stable cash flow. It sells and distributes power backed by government-regulated rates and fixed-price PPAs with customers. The business model is very resilient because businesses and households need a steady supply of power.

NextEra Energy has one of the best financial profiles in the electric utility sector. It features one of the highest credit ratings in its peer group. NextEra also has a conservative dividend payout ratio for a utility. Those factors enable NextEra to pay a stable and growing dividend -- it expects to grow its payout at a 10% annual rate through 2024 -- making it an excellent renewable energy dividend stock.

TC Energy

TC Energy is one of the largest natural gas pipeline operators in North America. It has natural gas pipelines in the U.S., Mexico, and its home country of Canada. In addition, the company owns a premier liquids pipeline system, making it one of Canada's leading oil exporters. It’s also one of the country’s largest power producers with a focus on nuclear energy and renewables.

These energy infrastructure assets generate relatively stable cash flows. The company leases its capacity under fee-based contracts and regulated rates. This low-risk business model has proven to be highly durable as TC Energy generates steady cash flow in all market environments.

Meanwhile, the company has a conservative dividend payout ratio. It also has one of the top credit ratings in the pipeline sector. Those factors give it the financial flexibility to continue expanding its pipeline network and its dividend. They also make TC Energy one of the lower-risk companies in the energy sector.

More on the energy sector:

How to invest in the energy sector

The energy sector is a challenging one for investors, especially oil and natural gas companies. Energy prices can change in a heartbeat. This volatility can have a massive impact on the sector, as well as on the global economy.

We’ve seen this firsthand in recent years. Oil and natural gas prices plunged during the early days of the pandemic as demand dried up. However, they rebounded sharply in 2021 as consumption recovered. They continued their ascent in 2022, hitting multi-decade highs after Russia invaded Ukraine.

Because of the impact commodity price volatility can have on the energy sector, investors need to understand how to invest in energy stocks. That includes keeping downside risk in mind and not allocating too much of a portfolio to one energy stock or the industry as a whole. Investors should focus on oil and natural gas companies with the financial and operational strength to survive if industry conditions significantly deteriorate.

Factors that increase an energy company's durability include:

• A low-risk business model: For oil and natural gas producers, this means having diversified operations and low production costs. Meanwhile, energy infrastructure companies should have stable revenue with minimal exposure to fluctuations in volumes or pricing, e.g., operations supported by regulated rates or long-term fixed-fee contracts.
• A strong financial profile: Balance sheet factors to consider are a high investment-grade credit rating, lots of liquidity (cash on hand and borrowing capacity), and minimal near-term debt maturities. In addition, it should have a conservative dividend payout ratio compared to its peers.
• Manageable capital spending programs financed primarily with post-dividend free cash flow and prudent use of debt.

Energy companies with these characteristics will be in a better position to withstand the inevitable cyclical downturns. That means they'll still be around when market conditions improve. Furthermore, they'll have more flexibility than their weaker peers to capture opportunities that can create value for their investors.

Energy stocks are important but risky

The energy sector is vital to the global economy because it provides the fuel and power needed to drive trade and travel. However, when the economy slows, as it did during the COVID-19 pandemic, it can have a major impact on energy demand and prices. That can put significant weight on energy stock prices. Conversely, when the economy hits the accelerator, which happened in 2021, demand soars and usually takes prices up with it.

Because of that, the best energy stocks to buy are those that can easily survive a downturn. That factor also puts them in the best position to thrive when market conditions improve. Another factor energy stock investors should consider is focusing more attention on cleaner energy companies using renewable sources. That’s especially important during the Biden administration, given its pledge to put the country on a path toward an emissions-free future.