Oil stocks have been showing some weakness lately, but are really taking a hit on Wednesday. Crude oil prices are hitting new lows this afternoon and are down over 5.5% on the day. Natural gas is down too, off about 3%, and faces its third daily decline in a row. That follows a 5.1% dip on Friday and a 7.3% decline on Tuesday.
Energy has been the leading sector in the stock market all year and over the past 12 months. That’s as oil, natural gas, and gasoline prices have surged amid soaring inflation and strong demand. Supply chain disruptions haven’t helped, while the war between Russia and Ukraine has only — excuse the pun — poured fuel on the fire.
Stocks like Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX) and Warren Buffett’s darling Occidental Petroleum (NYSE:OXY) are rebounding from today’s lows, but it’s hard to ignore a selloff of this magnitude.
Could we be looking at a potential deflation trade, along with a rotation out of oil stocks into tech stocks? The former has been an outperformer, while the latter has badly lagged.
Can Oil Stocks Continue to Fall?
An energy crisis in California, Europe and other parts of the world is driving demand higher. These real-world situations have been the catalysts to higher energy prices (and higher energy stocks). However, oil prices — and thus, oil stocks — face multiple headwinds in today’s world.
Specifically, the Federal Reserve is strengthening the dollar and raising interest rates in an attempt to kill — not just curb — inflation. The Bank of Canada, European Central Bank and others are doing so as well. Lockdowns in other parts of the world, most notably in China, are also an ongoing risk.
Not only do we risk a recession here in the U.S. partially as a result of tightening liquidity, but combined with other parts of the world that are facing a true energy crisis, we also face the risk of a global recession. With multiple headwinds working against oil prices and oil stocks, there’s only one main catalyst holding up: Real-world demand.
If that demand collapses due to a decrease in economic growth, then energy prices could tumble lower.
So what will happen with oil stocks? These firms are immensely profitable and many have a low valuation. But if energy prices begin to tank, there will be no saving these stocks, unfortunately. They too will need to correct if that’s the case.
On the date of publication, Bret Kenwell did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.