The disconnect between gains in energy stocks and the slump in crude oil prices suggests that something has to give. Energy market analysts say oil prices are more likely to rise than stocks are to fall.
The S&P 500 Energy Sector SPDR ETF
has risen 50% this year, representing the best-performing sector in the S&P 500 Index
Top-five holdings are Exxon Mobil
Energy stocks hit a 2022 high in mid-November, even as WTI crude
has gradually sunk 40% since June. Russia’s invasion of Ukraine ignited oil’s rally in the first half of the year. Still, energy stocks have had staying power, as many are keeping production stable while lowering debt and buying back shares.
Crude-oil prices retreat
Crude oil’s weakness stems from concerns of lower Chinese demand as the country continues with its zero-covid lockdown policy, says Stacey Morris, head of energy research at financial consultancy VettaFi. Market participants also have been worried about the impact of a slowing global economy on energy demand.
Focusing on oil’s price overlooks the bigger energy picture, Morris says. Front-month natural gas futures prices are also down from this year’s highs, but are up 90% year-to-date. That’s significant, since many energy companies will produce natural gas when they drill for crude oil.
The spread between crude-oil prices and the eventual products, known as distillate crack spreads, remains high, says Jay Hatfield, CEO of InfraCap, an energy infrastructure investment firm. That’s why he thinks concerns over front-month crude oil price weakness is overdone. He estimates crude oil prices will range between $85 and $105 as the market heads into winter.
Energy-stock prices ride high
Stewart Glickman, deputy research director at CFRA Research, says that while energy stocks are sharply outperforming the commodity, the same isn’t true over the past three to five years.
“In some ways, I think this is a bit of a catchup. Over a longer-term basis, it’s actually not so far out of whack,” Glickman says.
While energy prices are off their highs, the structural supply issue for the commodity hasn’t changed, which is a systematic underinvestment in crude oil, Glickman says.
Underinvestment will ultimately support energy stocks in the longer term, says Bob Leininger, a portfolio manager at Gabelli Funds, including the $2 billion Gabelli Equity Trust
Looking at oil prices across the futures curve, most deferred contract months are trading around $75 to $80 a barrel. Those contracts haven’t experienced the same price gyrations as the nearby contract, which suggests stability and should give some comfort to energy-stock bulls. VettaFi’s Morris says U.S. energy firms are still making profits by pumping at these lower levels.
Investors can’t make back-of-the-envelope math calculations to equate the price of crude oil with energy firms, InfraCap’s Hatfield says, especially the so-called super majors such as Exxon Mobil and Chevron, which are diversified over several business lines.
“Everybody thinks there’s a simple equation [of] oil price times volume equals Chevron price,” he says.
How to differentiate energy stocks
Charles Lemonides, founder of hedge fund ValueWorks, says investors shouldn’t necessarily look at oil stocks as a group, saying there’s been much variability in equity price action.
While he owns Bakken-based fracker Chord Energy Corp
and liquefied natural gas producer Cheniere Energy
ValueWorks has begun to sell short Occidental Petroleum
Lemonides says the price is elevated because it’s been heavily bought by billionaire investor Warren Buffett and mutual fund firm Dodge & Cox.
CFRA Research’s Glickman has a “buy” opinion on Exxon Mobil and Permian-basin fracker Pioneer Natural Resources
and rates EOG Resources a “strong buy.”
He’s positive on master limited partnerships as they increase pipeline capacity, especially to build natural gas capacity. Natural gas is often a byproduct of oil drilling, and that energy needs to be stored and moved. Glickman says several pipeline companies are publicly discussing interest in building more gas takeaway capacity, which he says will likely be sent to the Gulf Coast.
“Then you can liquefy it, put it on a boat and send it to Europe, which is looking for anyone but Russia for gas,” he says.
Leininger says Gabelli owns Halliburton
and Schlumberger in the energy-services company space as a play on the need to increase energy infrastructure over the next two decades.
The energy-market watchers say commodity prices are likely to fluctuate in the coming months as long as Russia continues to dominate supply-side news.
“The bull case for energy is not going away unless the energy crisis in Europe is resolved,” InfraCap’s Hatfield says.