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Can Struggling Energy Stocks Find a Way Out Amid the Red Sea Tensions?
Energy stocks were among the worst-performing sectors in the US stock market last year. While the S&P 500 achieved a return of 24% in 2023, the energy sector fell by 4.8% for the whole year, second only to Utilities. However, analysts point out that the current valuation of energy stocks is at a "historical low" and their profitability is improving. The intensification of geopolitical risks in the Red Sea may push up oil prices in the short term, thus triggering a rebound in energy stocks that are struggling.
In 2023, $Crude Oil Futures(MAY5) (CLmain.US)$ fell by 11.4%, and $Brent Last Day Financial Futures(JUN5) (BZmain.US)$ fell by 10.82%, both experiencing annual declines for the first time since 2020. The significant drop in oil prices was the main reason for the poor performance of the energy sector from mid-September to early December last year.
However, the Red Sea crisis that erupted in December continued to escalate, causing great disruptions to the global supply chain and significantly affecting oil and natural gas prices. According to Bloomberg data, global freight charges have risen by 120% in the past six weeks, and oil prices, which had fallen for two consecutive months, have rebounded under the threat of geopolitical risks. As of the latest update, $Crude Oil Futures(MAY5) (CLmain.US)$ were slightly below $73 per barrel, rebounding nearly 7% from the December lows.
Bob McNally, founder of Rapidan, said that there is no sign of easing tensions in the Middle East, and the current conflict between Israel and Hamas may be starting to bring in larger oil disruptors. The risk of an oil supply shock from a geopolitical event is now at least 30%. McNally added that oil prices may need to rise 15% due to geopolitical risk. Morgan Stanley also stated that if transport costs push up commodity prices, the struggle to fight against inflation in the coming months may be stalled.
According to Matthew Maley, Chief Market Strategist at Miller Tabak, oil prices are currently leading the stock market.
"So if oil prices can break out a little bit from here, which would catch people a little off guard, this energy group is going to start playing catch up real quick."
According to MacroMicro data, the forward price-to-earnings (P/E) ratio for the energy sector is currently only 10.83 times, the lowest among all sectors and far below the S&P 500's P/E ratio of 19.61 times. Strategists at the Wells Fargo Investment Institute also stated that energy stocks are at "historically low" valuations. The relatively cheap valuation may be one of the factors that support energy stocks.
Investors are closely watching the upcoming earnings reports of energy stocks to gain insight into their 2023 profitability and to extract further information from the 2024 performance outlook. According to LSEG data, the energy sector's full-year profitability in 2023 is expected to be the worst among all sectors, declining by nearly 26% overall. However, according to MacroMicro data, its profitability is expected to increase by 1.29% in 2024. Although this level still lags behind the S&P 500's overall growth rate of 13.29% in 2024, the trend of improving energy profitability could boost stock prices.
Walter Todd, Chief Investment Officer at Greenwood Capital, pointed out that improving profitability trends and attractive valuations are among the factors supporting energy stocks, and that energy stocks could also become a hedge if geopolitical tensions intensify. Strategists at WFII also upgraded their rating on the energy industry from "neutral" to "favorable" this week."
On Monday, a US-owned cargo ship in the Red Sea was hit by a Houthi missile, marking what appears to be the first time the militants have successfully struck a US-owned or operated ship.
To make matters worse, a US official reportedly revealed to CNN that the recent US-led airstrikes on Houthi rebel targets in Yemen were only successful in eliminating less than a third of its overall offensive capabilities. This leaves the group with the majority of its capacity to target ships in the Red Sea, increasing the uncertainty of geopolitical conflict in the area and posing significant navigational hazards for this vital shipping route.
While the potential for supply chain disruptions and OPEC production cuts could potentially weaken global energy market supply capability and support oil prices, the outlook for increased supply from non-OPEC countries and a slowdown in demand growth may offset such effects.
Saudi Arabia's sales promotion through price cuts is a significant reflection of the weakness in oil market fundamentals. On January 7th, Saudi Aramco announced a reduction in February prices for flagship crude oil sales to all regions, citing competition from other sources of supply and concerns over oversupply.
Robert Pavlik, senior portfolio manager at Dakota Wealth Management, believes that oil is fairly priced, citing an anticipated slowdown in the US economy and doubts that the Middle East conflict will provide a sustained boost to the commodity.
Source: Reuters, Yahoo Finance, MacroMicro, CNN, Bloomberg, moomoo
Disclaimer: Moomoo Technologies Inc. is providing this content for information and educational use only.
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