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Why Oil Stocks Are Lagging Behind Soaring Crude Oil Prices

Over the past couple of months oil markets have been on fire, with oil prices gaining 30% since June after Saudi Arabia and Russia announced they would extend their production cuts and exports. The cuts have proven to be pretty effective, with commodity analysts estimating that global markets could be currently facing a deficit of as much as 3 million barrels per day. This implies that the rally is in-line with market fundamentals, unlike the previous situation where market sentiment was extremely bearish despite early signs of tightening supply.

It’s, therefore, surprising to find that energy stocks have been lagging the commodity they track by a significant margin. The energy market’s popular benchmark, the S&P 500 energy index has only managed a 14% gain over the timeframe, while its 6.5% return in the year-to-date badly lags the S&P 500’s 15.2% gain over the timeframe.

It’s quite clear that energy investors don’t share the enthusiasm of hedge funds and speculators, which have become the most bullish in nearly two years. It’s even more perplexing when you consider the energy sector is currently the cheapest in the market, with the current sector PE ratio of 7.6 less than half the S&P 500’s average at 19.9.

To be fair, there’s a method to this madness, with Chevron Inc.’s (NYSE:CVX) latest debacle at its giant LNG plants in Australia helping to sour sentiment. CVX accounts for a chunky 17 percent of the S&P 500 energy index.

Underwhelming Earnings

But there’s a lot more to it. The latest earnings season is now almost complete, and the erstwhile high-flying oil and gas sector has left a lot to be desired. Whereas Q3 2023 earnings growth for the S&P 500 clocked in at a miniscule 0.2%, well below the 5-year average earnings growth rate of 12.0%, it actually marked the first time the market managed to post positive growth in four consecutive quarters.

In contrast, the monster earnings growth, high commodity prices and stock rally the energy sector enjoyed over the past two years set it up for some really tough comps. The sector has reported the largest earnings decline of all eleven sectors at a steep -40.1%, thanks to lower year-over-year oil prices taking a massive toll on the bottomline. Indeed, despite the recent rise in oil and gas prices, the average price of oil to date in Q3 2023 ($80.39) is still 12% below the average price for oil in Q3 2022 ($91.43).

Related: Hedge Funds Are Sold On $100 Oil

At the sub-industry level, three of the five sub-industries in the sector reported (year-over-year) decrease in earnings of more than 20%: Integrated Oil & Gas (-50%), Oil & Gas Exploration & Production (-44%), and Oil & Gas Refining & Marketing (-22%). On the other hand, two sub-industries have reported (year-over-year) earnings growth: Oil & Gas Equipment & Services (29%) and Oil & Gas Storage & Transportation (5%). The Energy sector has also emerged as the largest detractor to overall earnings growth for the entire index. To get an idea of how badly the sector has pulled down everyone else, FactSet has reported that if this sector were excluded, the estimated (year-over-year) earnings growth rate for the S&P 500 would improve to 5.8% from 0.2%.

Things were not much better on the revenue side with the sector reporting the largest (year-over-year) revenue decline of all eleven sectors at -19.9%, again thanks to lower year-over-year oil prices. At the sub-industry level, four of the five sub-industries in the sector reported revenues declines of more than 10%: Oil & Gas Exploration & Production (-27%), Integrated Oil & Gas (-26%), Oil & Gas Refining & Marketing (-14%), and Oil & Gas Storage & Transportation (-14%). On the other hand, the Oil & Gas Equipment & Services (14%) sub-industry was the only sub-industry that reported revenue growth in the sector.

The Big 3 oilfield services (OFS) companies Baker Hughes (NASDAQ:BKR), Halliburton (NYSE:HAL) and Schlumberger (NYSE:SLB) have posted impressive top-and bottom-line growth, thanks to robust demand for their services as well as a surge in offshore oil and gas drilling.

Wall Street Remains Bullish

Luckily for the oil and gas bulls, Wall Street is not about to give up on the sector. FactSet has reported that overall, Wall Street has 11,062 ratings on stocks in the S&P 500, of which 54.4% are Buy ratings, 40.0% are Hold ratings, and 5.6% are Sell ratings. Interestingly, at the sector level, the Energy (64%) sector has the highest percentage of Buy ratings, while the Consumer Staples (45%) sector has the lowest percentage of Buy ratings.

It’s not hard to see why Wall Street remains largely bullish on energy, with most analysts expecting oil prices to remain high or go even higher.

The energy stocks will obviously beat because of higher energy costs right now. The world cannot have a disruption in energy right now because the supply-demand imbalance in the world is very fragile,” Louis Navellier, chief investment officer at Navellier & Associates Inc., has said in a note.

As long as Saudi Arabia and OPEC+ maintain production discipline, oil bulls appear poised to win in the long run.

By Alex Kimani for Oilprice.com\

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