Recession concerns and profit taking contributed to disproportionate weakness in energy in recent weeks. Intensifying political rhetoric around energy companies likely didn’t help. Energy stocks have fallen approximately 20% from their multi-year highs seen in the second week of June, even as oil prices have been resilient by comparison – down around 12%. Recessions tend to be challenging for the energy space because oil demand typically declines and that puts downward pressure on oil prices.
In a recession, diesel demand tends to be particularly impacted given its greater sensitivity to economic activity. Looking back at the financial crisis, global diesel demand fell by 1.7% from 2007 to 2009, and global gasoline demand was down 0.9% based on data from the International Energy Agency. In the US, diesel demand fell 13.5% from 2007 to 2009 while gasoline demand only fell 3.1% according to the Energy Information Administration.
A recession would likely weigh on global oil demand, but it is difficult to gauge how significant that demand impact would be and the ultimate effect on oil prices given other supply and demand crosscurrents. For example, pent-up travel demand coming out of the pandemic and the easing of lockdowns in China should be supportive for demand. From a supply standpoint, the shift away from Russian crude will continue, and it remains to be seen how many barrels can be soaked up by Asian buyers as the EU shuns Russian imports. Incremental supply from Iran, Libya or other producers is possible. In the US, growth will likely be constrained by producer discipline and shortages in the oil patch from labor to fracking sand. If the magnitude of the demand impact is relatively modest and supply remains constrained, oil prices could hold up reasonably well through a recession, which should bode well for energy stocks.
If recession concerns moderate, energy stocks should recover. Earnings season is just a few weeks away and could be a catalyst. Solid results driven by the strong macro environment along with positive commentary around free cash flow generation and returning cash to shareholders could bolster energy equities. Headline-driven volatility is likely to continue for oil prices and energy stocks in the near term, but energy investors can take some consolation in positive company-level developments made possible by excess cash flows and a focus on shareholder returns.
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