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HomeUncategorizedOil Prices and Energy Stocks Are Headed in Different Directions. What Gives?

Oil Prices and Energy Stocks Are Headed in Different Directions. What Gives?

Oil is sitting out Wall Street’s year-end rally.

While recent hopes that inflation has peaked sparked sharp gains in stocks and bonds, oil prices just bounced off their 2022 lows, hit by worries about slowing global growth eating into demand for fuel. Early gains for crude Monday, triggered by easing Covid restrictions in China and a price cap on Russian oil, quickly petered out.

The divide is especially stark between oil prices and shares of energy producers—the stock market’s brightest performers in a tough year. Energy shares are up almost two-thirds this year, and have continued climbing even as U.S. crude futures slid roughly 35% from their high point in the wake of Russia’s invasion of Ukraine to end up nearly flat. 

Last month marked the first time since 2006 that the S&P 500 energy sector has traded within 3% of a 12-month high while the price of West Texas Intermediate retreated more than 25% from its respective one-year peak, according to Bespoke Investment Group.  

The divergence has surprised some on Wall Street, where shares of drillers and miners tend to rise and fall with the prices of the commodities they produce. Many expect a rebound in oil prices to narrow the gap, allowing companies such as Exxon Mobil Corp. and

Chevron Corp.

to boost dividends and stock buybacks, along with capital investments that are key for future oil production. A further decline could undermine producers’ banner profits—and the backstop they have provided to shaky stock indexes.  

Stock investors are betting that recent moves by OPEC and its Russian-led allies to keep production quotas unchanged, as well as Western governments’ $60-a-barrel price cap on Russian crude, will keep global supplies tight. Futures contracts for U.S. crude closed Monday 3.8% lower at $76.93 a barrel, its fourth-lowest settle of the year. 

“In the oil market, do we know prices are going to go higher? No,” said

Cole Smead,

president of Smead Capital Management. “But we see incredible tension between the supply the market wants and the price producers think they can get oil to market.”

Lower crude prices can boost profits at non-oil companies by reducing costs and easing inflationary pressure. But some analysts also view lower oil prices as a sign of a slowing economy—and bad news for the broader stock market’s prospects.  

In four of five other major splits between oil prices and energy stocks since 1990, oil rallied over the following 12 months, according to Bespoke. 

In November 2006, oil companies were in the midst of a yearslong bull run and global crude inventories were high. The S&P 500 energy sector rose 26.8% over the next year while oil prices surged 69%, said

Paul Hickey,

co-founder of Bespoke. 

During that and other periods, however, energy stocks hadn’t seen two-year rolling returns that Bespoke said touched an unprecedented 227% in November. That adds to worries that stocks’ hottest sector could be due to cool off. 

“This pace of gains for a sector can’t last forever, especially when one of the key commodities driving its profits has been declining,” Mr. Hickey wrote in a note. 

Some structural factors are weighing on crude prices. One impediment to an oil rebound: traders who have responded to a year of exceptionally high volatility by taking their chips off the table.

Fund managers trading oil futures based on systematic trend-following strategies have been selling their positions for months, according to a TD Securities model of their activities, as their algorithms signaled higher risk and lower rewards. 

Such funds constitute about 30% of trading volumes but have an outsize influence driving trading flows once the market finds a direction, said TD Securities senior commodity strategist Daniel Ghali. 

“They are, by far, the most dominant speculative force in commodities,” Mr. Ghali said. 

Oil sales by banks and trading houses accelerated in recent weeks as Covid outbreaks called Beijing’s reopening schedule into question, spurring protests. Financial investors reduced the net length of their positions in Brent and WTI crude to their lowest levels since 2020, according to UBS. 

Traders are now more reluctant to place new bets, brokers say, and that reluctance could compound existing volatility. 

“Their time horizons are very short,” said John Augustine, chief investment officer for

Huntington National Bank.

U.S. gas prices have been up and down throughout the year and now more uncertainty is on the horizon as a European Union embargo on Russian oil imports kicks in along with a price cap on crude out of Russia. WSJ explains how these moves could impact prices at the pump for Americans. Illustration: WSJ

U.S. crude prices have hovered near their 2022 lows despite Chinese oil imports rising for four consecutive months since stringent second-quarter lockdowns, according to commodity analytics firm Kpler.

The global need for oil is going to recover to prepandemic levels “unless you think the world is ending,” said Robert Minter, director of ETF investment strategy at fund manager

Abrdn.

SHARE YOUR THOUGHTS

What is your outlook for energy stocks? Join the conversation below.

Still, many economists expect further interest-rate increases in the U.S., Europe and other large economies may spark recessions and crimp demand for products such as diesel and gasoline. 

China “is going to face a very tough time to meet that gap,” said Francisco Blanch, head of commodities and derivatives research for

Bank of America.

“And the only solution really is to expand domestic demand.”

Write to David Uberti at david.uberti@wsj.com and Bob Henderson at bob.henderson@wsj.com

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