Energy Stocks Surge in Third Quarter

by Warren Seah

Energy stocks have experienced a remarkable surge in the third quarter, as oil prices approach $100 per barrel. Exxon Mobil reached a record high on Wednesday, distinguishing energy as the sole sector of the S&P 500 that has traded positively over the past month.

Potential Challenges Ahead

Despite this impressive performance, the future may pose some challenges for energy stocks. The bullish sentiment among oil traders suggests that new investments may have little impact on stock prices. Furthermore, analysts anticipate a potential decrease in the bullish supply-demand dynamics for the upcoming quarter.

Disparity Between Oil Stocks and Commodity

There exists a notable disconnect between oil stocks and the underlying commodity, highlighting underlying issues within the market. While Brent crude futures, the global benchmark, have risen by 27% since the end of June, reaching approximately $96, the SPDR S&P Oil & Gas Exploration & Production ETF (ticker: XOP) has only seen a 17% increase during the same period.

Expectations for Lower Oil Prices

One explanation for this divergence is the expectation that oil prices will decrease next year. Futures contracts expiring one year from now indicate trading at around $84 per barrel, which is $12 below current prices. Bank of America analyst Doug Leggate suggests that the gains made by oil stocks are hindered by a “backwardated” price structure. This term describes a market where short-term prices are higher compared to future prices, causing long-term price projections to influence market discounts.

Oil Prices and Production Outlook

The recent surge in oil prices can be attributed to Russia and Saudi Arabia’s decision to cut production until the end of the year. This deliberate move is aimed at keeping prices high. However, there is a possibility that both countries might increase production next year, which could potentially lead to a decline in prices.

Impact of Oil Demand Weakness

Some analysts predict a weakening in oil demand, which has important implications for the market. Natasha Kaneva, head of the global commodities strategy team at J.P. Morgan, highlights that demand risks are shifting towards the downside. This shift is partially due to the surge in pump prices and the completion of the seasonal travel peak. As a result, the fourth quarter will see a greater concentration of demand in sectors that are highly sensitive to economic growth.

Notable Areas of Demand Decline

Kaneva points out that the decline in demand is particularly significant in key sectors such as U.S. gasoline and jet fuel. In terms of domestic air travel, there are indications that demand has reached its peak as financially constrained consumers opt for fewer trips. U.S. airlines are now reporting sales on the lower end of expectations and below historical seasonality patterns, following a summer season that witnessed record-breaking numbers of travelers.

Overall, while near-term sector free cash flow benefits from oil prices above $90, the depressed longer-dated prices due to excess spare capacity pose challenges for valuations, according to Leggate. Additionally, the potential decline in demand raises concerns for the future of the oil market, prompting the need for careful monitoring and analysis moving forward.

Leveraging Different Business Areas: A Potential Boost for Exxon

Exxon (XOM) and other players in the energy sector are constantly seeking ways to bolster their stocks. When oil prices experience a halt, alternative strategies become crucial. One such avenue that experts are considering is Exxon’s chemicals and specialty products business. This division focuses on developing higher-value substances derived from petroleum or biomass.

Recently, Jefferies analyst Lloyd Byrne expressed optimism regarding this aspect of Exxon’s operations. Upgrading his price target to $140, an 18% increase from recent prices, Byrne believes that the chemicals and specialty products business could bring forth a new wave of opportunities for the company.

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