Is it smart to make energy stocks a part of a retiree’s income plan when the demand for oil is low, the end of the fossil fuel era many be nearing, and a new generation of ESG-oriented investors and portfolio managers avoid them?

Consider that Exxon Mobil, once the largest capitalization company in the world, has a dividend yield that hovers around 10 percent. The highly-respected and well-managed Chevron has a dividend yield of about 7 percent. With interest rates at historical lows, the yields available throughout the energy sector can be very tempting to yield-oriented investors, like retirees.

The Case for Energy’s High Dividends  

The case for investing in energy-related stocks rests on two expectations: low oil prices are not permanent and fossil fuels will not be replaced as an energy source anytime soon.

Oil prices are notorious for wide price swings over multiple-year cycles. The best remedy for low oil prices is low oil prices, which is to say that low prices have historically driven higher demand and pushed prices higher.

Though OPEC admits that demand in wealthier countries may have already peaked, they believe that the world’s overall demand for oil is unlikely to peak for another 20 years. In other words, demand declines in the developed world will be replaced by new demand from developing nations.

The energy sector is not monolithic, so companies with diversified businesses, strong balance sheets, meaningful R&D efforts in alternative energy sources and a tilt toward natural gas—a possible bridge between today and a future of renewable energy sources—should hold up better than oil exploration and production companies that rely entirely on the price of oil to fund its dividend payments.

Midstream pipeline companies may also be a reliable source of dividends since they, as transporters of energy, are more insulated from the price swings in oil and gas.

The Case to be Wary of Energy’s High Dividends

Owing to the trend toward renewable energy, the oil markets will be fundamentally different. Whereas producers may have in the past agreed to produce less when prices are low to drive higher prices tomorrow, in a world of shrinking demand the incentive for producers may be to sell now, at any price, so as not to be saddled with a stranded asset.

This may result in a continuous downward pressure on oil prices, hurting companies’ ability to fund dividends.

Moreover, while a 5 percent dividend yield is satisfying in the moment, a more holistic view of an investment may be less rewarding as stock price declines overwhelm the value of the yield. With large investor segments electing to avoid fossil fuel investments, it’s hard to see where the demand comes from to hold up stock prices over the long-term.

Whatever side of the debate you fall on, it may be prudent to invest in energy with moderation and carefully watch those investments in the years to follow.

See referenced disclosure (2) at https://blog-dev.americanportfolios.com/disclosures/