After a strong 2017, it appears that investment spending in the U.S. energy sector may have slowed down. As shown in the chart below, recently released data indicates that energy sector capital expenditures (“capex”) decelerated in 2018, finishing at a level only modestly higher than 15 years ago. The implications of that weakness are clear – less spending, all else held equal, likely dragged on economic activity last year.

That said, the causes may be more nuanced. Looking at energy sector trends in 2018, three key issues can be identified: first, a significant oversupply in the global energy market; second, energy price weakness in the fourth quarter of last year; and third, heightened energy price volatility.

During the energy price recovery of the last several years, improved extraction technology, coupled with broad-based global growth, drove energy stockpiles higher. But when global growth cooled in 2018 in the wake of geopolitical uncertainty, supply did not contract to match the shrinking demand. Indeed, the U.S. Energy Information Administration (EIA) estimates that global production in 2018 outstripped global demand by roughly 500,000 barrels per day. This glut in supply led U.S. energy producers to curb investment spending until the imbalance could be rectified.

Softening global demand in the fourth quarter likely also pushed energy prices lower, especially as higher-demand economies (notably China) decelerated in response to trade disputes with the U.S. This softening likely further contributed to a pullback in capex.

Finally, as was the case with broader-risk markets in 2018, lingering uncertainty around the global economic expansion and policy led to heightened volatility in the energy market: WTI prices ranged from $45 a barrel to $74 a barrel in 2018, compared to more meager range of $43 to $60 in 2017.

With the potential for energy markets to remain volatile and supply to remain high, it is unclear whether capex in this sector will return in the near future. This dynamic, coupled with broader uncertainty around the trajectory of global growth as well as both fiscal and monetary policy, could weigh on investment spending more broadly throughout 2019. That said, energy sector stocks currently provide investors with a healthy dividend yield, which can help protect a broader portfolio against elevated volatility this year. As such, it would not be prudent to abandon the sector.

Energy sector capex has weakened

Market cap-weighted capital expenditure, $ billions

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Source: S&P, J.P. Morgan Asset Management. Data are as of March 28, 2019.