Will energy stocks extend their outperformance in 2022? – Stock Market News



Since the beginning of 2022, there  has only been one sector in the S&P 500 index that experienced significant gains amid a doomy period for equity markets and risky assets in general. The energy sector has climbed more than 50% as oil prices have been on a sustained uptrend due to the long-lasting supply-demand imbalance, which is triggered by a combination of factors. Historically, the energy sector has generated the highest return of all 16 equity sectors during rising interest rate environments, meanwhile there are still no concrete signs that energy commodity prices will cool off soon. Therefore, will the energy stocks' dominance continue or is the rally overstretched?

Stellar performance in 2022

The energy sector has seen a remarkable surge since economies started rebounding from the Covid-19 pandemic. More precisely, the pandemic-induced recession forced oil producers to pump less as demand slumped horrifically. Then, when the world started to cautiously emerge from the pandemic, the constrained supply, alongside the chronic under-investment in fossil fuels due to the global intensifying efforts for a quick transition towards clean energy, induced upward pressures on energy commodities.

Aside from that, the Russian invasion of Ukraine and the consequent sanctions from Western allies on Russian energy exports caused the already elevated prices to spike further. Furthermore, the OPEC+ cartel has been refusing to hike its output despite continuous calls from the US and major European governments. Summing up, all the above have acted as catalysts that boosted oil prices, enabling energy companies to experience a big jump in both earnings and revenue figures.

Further gains are on the table

Even if black gold is currently trading at historically high levels, its near-term prospects remain bullish. In the upcoming months, the demand for oil is expected to rise further as traveling usually heats up during the summer months. Additionally, Shanghai’s exit from Covid-19 restrictions will lead to the re-opening of factories and manufacturing facilities, causing a spike in oil demand.

Last week, the EU agreed on new sanctions against Russia, which essentially means that the Union will block 90% of Russian oil imports till the end of the year. This move will increase Europe’s reliance on the US for oil, bolstering US energy companies’ earnings, while keeping global oil prices elevated for longer.

Lastly, in a period of rising interest rates, energy companies are expected to perform well, benefiting from investors’ rotation towards value stocks. Oil companies are mostly large and established firms that do not depend heavily on external financing to fund their operations, making them far more appealing than growth stocks and specifically tech stocks, in the current environment.

Looming risks on the horizon

In the short-term, geopolitical flare-ups and supply constraints might continue to keep the price of energy commodities elevated, further boosting the sector’s performance. However, as soon as the supply-demand imbalance is resolved, energy prices are likely to come back down to earth and energy companies’ shares will probably experience a significant pullback.

Recently, there have been increasing rumors that some OPEC members are exploring the idea of suspending Russia’s participation in an imminent oil-production deal. Exempting Russia from their oil-production targets could potentially enable other members of the OPEC cartel to increase their output, which is something that Western countries have repeatedly pressed them to do in order to cool down oil prices. Should that scenario play out, petroleum prices will drop, hurting energy stocks.

Finally, rising carbon prices due to more and more countries adopting carbon taxes to incentivize the quicker transmission to clean energy sources are also expected to largely weigh on oil stocks. Nevertheless, with the energy crisis constantly deteriorating many countries might now have second thoughts about increasing their carbon taxes.

The verdict

To sum up, it is clear that there is still significant upside potential for energy stocks in the current environment of higher interest rates, especially as long as the energy crisis lingers. Nonetheless, if the imbalance in oil markets is finally resolved, oil companies will  face tremendous downside pressures.

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