Is Energy The Place For Investors To Hide As Stocks Tumble?

It has been a rough couple of weeks for stock investors. The S&P 500 lost close to ten percent from its August 16^th high to its Thursday low as the market came to grips with the reality of the Fed's rate hikes and their intention to continue on that path until inflation is beaten, even if that means risking a full-blown recession. Things came to a head at the end of last week when Jay Powell, in a speech at a Jackson Hole, Wyoming summit, indulged in some serious central-bank-splaining as he told the smart people on Wall Street just that, that rate hikes could slow economic growth.

Given that a recession is now a real possibility, the immediate future for the stock market now looks a little bleak, and that has led to the usual rush of articles and TV interviews giving advice as to where investors can hide. Whenever that happens these days, it seems, energy is the first place suggested. The theory is that it is a recession proof sector. I mean, we all need energy, right, whatever the economic conditions? The problem, though, is that the main influence on stocks in the energy sector isn't demand in the economy, it is the price of oil, and the prospects there aren't too hot right now.

Of course, oil prices themselves are sensitive to actual and projected economic growth, but that isn't the only thing that moves them. There is a supply side to the equation as well and, for a while now, supply has been restricted. The obvious reason for that is the Russian invasion of Ukraine and resulting sanctions from other countries. Some reports indicate that Russian oil is still finding its way onto the market but still, those sanctions won't have helped. However, the main reason for oil's climb was longer-term than that. It was that in the face of a seemingly unstoppable global move away from fossil fuels and the increasing impact of ESG considerations on investors, big oil companies were loath to spend big money investing in long-term projects.

What is often not fully understood, though, is the time lag between capital expenditure and actual output in these projects. E&P is not a quick process when it comes to new oil and gas fields, with studies showing that it takes around five years to get product from a newly discovered source. Wells can be drilled much quicker in existing fields, but even then, it is not until months after drilling commences that output of any kind starts.

So, if you are looking at capex as an indicator of supply, you have to look at long-term trends and, when you do that, it looks as though the next few months could see global output increases. After dropping since 2018, global oil and gas capex expenditure actually grew in 2021 by 5.5% and is forecast to pile another 16% or so growth on top of that this year. You could argue that that is just replacing production lost in 2020 as oil collapsed, but that doesn't change the fact that the trend towards lower capex has reversed over a two-year stretch.

The oil that results from that is just beginning to hit the market, which raises a scary possibility for oil prices and, as a result, energy sector stocks. It could be that, indeed it is likely, that supply will be increasing significantly over the next few months, just as the economic pain that Powell told us he saw as a necessary price to pay to achieve price stability begins to be felt. And you don't need me to tell you what happens to price when falling demand meets rising supply…

So, the next time you hear an analyst tell you that energy is going to outperform in the falling market they all seem to be anticipating, check on oil prices. If the chart there continues to look like it has since the beginning of June (see above), then take that advice with a big old pinch of salt!