Rating the Energy Companies

I wrote last year about the energy problem - the underperformance of some social indexes as energy stocks took over the market in recent years.  It is not just an energy problem, it's a utility problem, too.  Here are the returns to the S&P 500 by sector for the three years ended 8/6/06 (source: Bloomberg):

Energy	131%
Utilities	66%
Materials	43%
Industrials	39%
Financials	33%
Telecom Serv	32%
Cons Staples	25%
Cons Disret	20%
Health Care	14%
Info Tech	14%

Many social investors avoid both energy companies and utilities - energy companies because of their environmental problems, and utilities because most are involved in nuclear power.  Whether these restrictions make sense can be debated.  A financial academic once asked me why we excluded stocks that will outperform with higher energy prices when they are the best thing that could happen to the alternative energy sector (they create a subsidy to development of cleaner energy).  And some influential people are arguing that, given our climate issues, nuclear could be part of the solution (Socialfunds covered this very well last summer).

Anyway, it's hard to outperform when you're underweighted the two best-performing sectors in the market.  The Domini Social Index is still ahead of the S&P 500 from inception and over the past ten years, but its three year record has been well behind the broader market as of 7/31/06 (annualized +8.5% vs. +10.8% - full performance details here).  The Calvert Social Index is in the same boat, up 8.0% over the same period (performance details here).

There are a couple of points I'd like to make about this:

• Social investors as individuals need to think hard about how they're going to handle these issues.  Energy matters a lot, not just in financial markets, but in the real world.  Economist James Hamilton has written intelligently about both the possibility we are near peak global oil production, and the impact of higher oil prices on the economy.  WSJ Online has a good online piece with contributions from both Hamilton and Robert Kaufman of Boston University.
• There are energy investments that are palatable to some social investors.  There are both ETFs and mutual funds focusing on clean energy.
• Nothing lasts forever.  Lee Raymond recently said "the seeds are being sown right now for another turn in the cycle of the oil industry.  For those people who think there will not be a day of reckoning on the other side, and I hope I live long enough to see it ... it just takes a long time in this industry for supply and demand to react. This isn't like going out and producing a few more semiconductors."  I have no idea if he's right, but it's something to think about.

And finally, I get a chance to mention the Canadia social research firm Jantzi Research on this blog.  Founder Michael Jantzi has been involved in social research since 1990, and knows what he's doing.  They have just published a report reviewing the sustainability records of 23 large energy companies.  BP comes out at the top of the heap, which is consistent with other research I've seen.