Crude prices and energy stocks are diverging of late?

Oil and energy stocks are diverging
Oil and energy stocks are diverging

by 5paisa Research Team Last Updated: Dec 12, 2022 - 07:36 pm 8.1k Views
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There is an anomalous trend that is seen in the world in the last few months. Normally, when the price of oil goes up, the oil stocks especially those in the oil extraction and the oil refining business experience higher realizations and higher margins. Thus, these stocks also do well in the market. That was the trend till June 2022. However, in the second half of the year, the trend is changing. Energy prices are down sharply. For example, crude is down from $120/bbl to $79/bbl. However, oil companies continue to do extremely well. That trend is visible in the Indian context also. What explains this anomalous trend and what does it mean for the future of oil and gas stocks in India and across the world?

It is not just the stock prices, but even the financials are improving. In countries like the US, the oil companies are seeing record top line and bottom line numbers. That is the confusion. Normally, such a performance has been associated with prices of oil going up sharply. For instance, Exxon was the most profitable and it had the highest market cap in the world when oil had touched $135/bbl in the year 2008. However, since then, Exxon struggled to regain that valuation level. Now, it is ironic that the oil companies across the world are seeing a surge in sales, profits and market cap at a time when the oil prices are headed lower. What explains this dichotomy, or is it a dichotomy at all?

In the first half of 2022, energy stocks and crude prices moved more or less in sync. There was a high correlation between the two. However, despite a fall in price of crude in the second half, oil stocks are doing extremely well. While core extraction may not be doing too well, other companies engaged in oil refining, marketing, consumable fuel, energy equipment and related services are all doing extremely well. Thus, the traditional correlation appear to have broken post July. There seems to be a decoupling of crude prices and the performance of oil companies. That is rather strange because traditionally, the correlation has been extremely high. The divergence has been prominent post July 2022.

What is driving this divergence between crude and oil stocks

Broadly, there appear to be 2 factors that is leading to this divergence between crude oil performance and the financial and stock market performance of oil companies.

  • The first reason for this divergence is consistently falling inflation expectations. We are talking about inflation expectations and not about actual inflation. This comes amidst weakening consumer demand. What is being lost due to weak crude prices is being made by robust demand for oil products as low inflation expectations is driving a surge in consumption.

  • The second factor brings out why oil stocks are doing well despite falling crude prices. The reason is that the energy companies are expected to witness substantial growth in the next few months, despite oil prices coming down. Remember that with oil in a down trend since 2014, most oil companies are still grossly undervalued despite above-average earnings growth.

That brings us to the million dollar quest, will this divergence last? That is hard to say, but it looks like oil stocks will have a long making up for the lost 8 years in the market. Surely, the oil companies are not going to be complaining.


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