How Long Will the Energy Sector’s Struggles Last?

Energy_Sector_Performance

One of the largest upheavals in financial markets during the past year has been the plunge in the price of oil. The price of West Texas Intermediate crude oil (one of the main gauges of “the oil price”) has fallen from over $100 per barrel in July 2014 to around $45 per barrel. This decline has decimated the energy sector, which has lost almost 30% of its value over the past year while the overall US stock market has gained more than 10%. Is the energy sector’s underperformance a short-term aberration or part of a longer-term trend?

Part of that answer depends on the outlook for the oil price. After rallying a bit this spring, the oil price resumed its descent in July. The prospect of increased Iranian oil production following the country’s nuclear deal with the US and other countries, high levels of global oil production, and worries about a potential slowdown in China’s economy all likely contributed to the fall. Each of these factors could persist for a while, so the oil price may not bounce back any time soon.

Another part of that answer depends on whether energy companies can adapt to lower oil prices by reducing their costs, for example by decreasing the size of their workforces and investing less in new exploration. By some estimates there have been almost 200,000 layoffs in the global oil industry since the middle of last year. The lower supply resulting from these changes could help the oil price arrest its decline and at least partially restore energy companies’ profits.

But low oil prices probably don’t explain all of the losses for energy stocks. In fact, the sector’s 40% underperformance compared to the broader stock market during the past year is far more extreme than during other recent oil price declines, even the 70% collapse in the oil price during the second half of 2008. It’s therefore likely that longer-term factors have contributed to the sector’s recent struggles as well.

Two such factors that have accelerated recently are the rise of alternative sources of energy and more stringent environmental regulations. These may be more difficult for energy companies to adapt to than a changing oil price, and they could continue to be a drag on energy stocks even when the oil price rebounds.

Topics: Energy Oil