If you want to know why many analysts expect S&P 500 Q1 earnings to fall, look no further than the Energy sector. Companies that suck crude out of the earth, process it, and sell refined products to consumers could face a worse than 20% year-over-year earnings decline, assuming Wall Street estimates are on target.
It all might go back to a slowing global economy that’s affected companies across multiple sectors. When global growth slows, as it did in Q4 and early Q1, the impact can often chip into demand for crude oil, the main Energy sector product. Fewer people and goods travel by plane, the rail and trucking industries see delivery declines, and industrial production in general sometimes eases (which we saw in the U.S. through much of Q1). All of this can lower demand for oil, and it appeared to soften crude prices through the first couple months of the year.
Soften, you ask? When crude oil prices are up more than 50% from their December bottom and gasoline costs more than $4 a gallon in parts of the U.S.?
It seems counter-intuitive, but yes, crude oil was relatively cheap for much of Q1, and it’s unclear if many of the big oil companies anticipated this. U.S. crude prices averaged around $55 a barrel in Q1, about 13% below the year-ago level, research firm CFRA said. In this environment, it could be hard for so-called “upstream” crude oil companies that make their livings drilling the commodity to post year-over-year earnings gains. Companies farther “down the stream” may do a little better, but perhaps not enough to counter the big guys who drill and explore for crude.
Even at current levels of about $64 a barrel for West Texas Intermediate (NYSE: WTI), crude trades well under highs of around $76 last fall. Prices bottomed near $42 in December, back when the stock market cratered, and have steadily climbed back over the last three months amid heavy U.S. demand and a relatively disciplined OPEC production cut. Though U.S. output remains near all-time highs of around 12 million barrels a day and new rigs have been coming on line, the drop in OPEC production appears to be a big factor pushing prices higher.
If prices remain elevated, that could potentially give Energy sector companies some help in coming quarters. Maybe that’s one reason the sector’s stock performance looks pretty strong year-to-date, up around 17%. However, just looking at Q1 from a business standpoint, the day-to-day story might have been a bit tough.
Figure 1: KEEPING UP DESPITE CHALLENGES: The energy sector (candlestick) hasn’t had much trouble keeping up with the S&P 500 Index (purple line) so far this year despite weak Q1 earnings expectations for the sector. Data Source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
Crude isn’t the only product Energy companies produce. Don’t forget natural gas, where prices have languished at around $2.70/MMBtu, not far from historic lows. Much of the natural gas abundance might be due in part to heavy U.S. crude output. Drilling for oil often releases natural gas, and apparently so much gas is being produced that some companies don’t know what to do with it. There were news reports in Q1 of at least one crude oil company in Texas apparently paying people to take natural gas away. In case you’re wondering, a negative price is pretty low, and not the best news for any companies trying to make a profit in the natural gas market.
Low prices for both natural gas and crude mean that for upstream producers (companies that drill for and sell the raw energy products), there was really no place to hide in Q1 unless they heavily hedged early at higher prices, CFRA observed recently.
However, the news isn’t necessarily all bad. Midstream companies (those that play a role in transportation, storage, and wholesale marketing of crude or refined petroleum products), might have benefited from higher volume in Q1, thanks in part to growing U.S. demand, according to some industry analysts. Crude stockpiles are now at around the five-year U.S. average, the Energy Information Administration reported last week, but gasoline and jet fuel demand over the last month have been trending above average.
Also, refiners might have seen some Q1 benefit from a widening of the spread between Brent and West Texas Intermediate (WTI) crude prices year-over-year, CFRA said.
On Q1 earnings calls from some of the major energy companies, investors might want to keep their ears open for any observations of industrial demand, in part because the Fed and various data have pointed to softening capital expenditures recently by many companies. Crude producers might be among companies that see a negative impact if businesses project slower growth and cut back on spending.
The Energy sector is also heavily affected by trade issues, and CEOs potentially could share their views on where demand might go assuming various possible outcomes of U.S. trade disputes with China and Europe. It was arguably trade worries that played a big role weighing down the price of crude in Q4 and early Q1, along with worries about a potential global economic slowdown. China’s gross domestic product (GDP) growth has been flagging, and that could be a major challenge for oil firms as they seek to build demand in Asia.
After earnings rose 80% for S&P 500 Energy firms in Q4, they’re expected to fall around 23% year-over-year in Q1, according to FactSet. A lot of the projected weakness could likely be due to softness in the crude oil market. In contrast, FactSet expects overall S&P 500 earnings (for all sectors) to fall 4.3% year-over-year.
Unlike some other S&P sectors, where strong revenue might make up for a little of the weakness in earnings, energy companies aren’t expected to look too impressive on the top line in Q1, either. FactSet expects revenue to fall 2.5% year-over-year for the sector.
Upcoming Earnings Dates
- Exxon Mobil Corporation (NYSE: XOM) says it will report Q1 earnings on Friday, April 26, before the market open.
- Chevron Corporation (NYSE: CVX) says it will report Q1 earnings on Friday, April 26, before the market open.
- ConocoPhillips (NYSE: COP) says it will hold its Q1 earnings call at 1 p.m. EDT on Tuesday, April 30.
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