Energy Was the Only Bright Spot in the Stock Market’s Gloom

The energy industry has become the stock market’s equivalent of a road hog. As financial markets around the world fell this spring on worries about high inflation, rising interest rates and the strength of the economy, energy was the only sector gaining ground.

Energy funds surged 18.4 percent, on average, in the first half of the year. Funds focused on every other area of the U.S. economy lost ground. Energy funds were also the best sector to own in 2021, according to data from Morningstar Direct. But investors with long memories will recall that the energy industry came in dead last in 2020 as pandemic shutdowns sent the economy into recession.

Now drivers are not alone in figuring out how to navigate energy costs. Russia’s war in Ukraine has created so much uncertainty about energy supplies that investors are having trouble making bets about the future of energy prices and the broader economy. A recent investing note from Charles Schwab said the broker did not recommend making significant bets on any market sector, including energy, “partly due to the highly volatile nature of the market and the uncertain trajectory of economic growth.”

Political factors have become at least as important to the current energy boom as the simple math of supply and demand. Oil prices surged after Russia’s invasion of Ukraine more than four months ago, briefly hitting an intraday trading high of nearly $140 a barrel on March 7. Oil was trading around $115 a barrel at the end of June, which is still roughly 55 percent higher than at the end of 2021. Prices have edged lower in recent weeks.

But there’s a catch. Mark Zandi, the chief economist at Moody’s Analytics, said these elevated prices were being sustained by the prospect of disrupted supply from Russia, particularly when the sanctions banning most Russian oil imports to the European Union kick in later this year. But if oil prices stay too high too long, they could set off a recession, and the economic slowdown would probably bring oil prices down.

Read More About Oil and Gas Prices

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  • ‘Only Bad Options’: Mr. Biden’s trip to Saudi Arabia is unlikely to reduce oil prices. And it is not clear that anything else he might do would work, either.
  • Summer Driving Season: The spike in gas prices is being driven in part by vacationers hitting the road. Here’s what our reporter saw on a recent trip.

He estimated that the U.S. economy could withstand prices of up to $125 a barrel. “That would put you within spitting distance of $6 a gallon for gasoline. That’s a recession,” he said. “Gas prices play an outsized role in our collective psyche. It’s about how we take drives, how we think about our entire financial situation. It affects our expectations for inflation.”

For the time being, at least, the impact of the sanctions, which are intended to punish Russia for its war on Ukraine, appears to be chiefly psychological. Russia earned about $100 billion from fossil fuel exports in the first 100 days of the war, according to a report from the Center for Research on Energy and Clean Air, an organization based in Finland.

President Biden at the Group of 7 meeting in Germany last month. The group discussed imposing a ceiling on the price paid for Russian oil.Credit…Kenny Holston for The New York Times

The recent meeting of the Group of 7 industrialized countries considered ways to impose a ceiling on the price paid for Russian oil, although it is unclear if a cap would work as intended. In the first 100 days of the war, Europe accounted for 61 percent of Russia’s oil sales. But China and India have emerged as key buyers, and their refiners may already be paying as much as $40 a barrel below the market price for Russian oil, according to S&P Global Commodity Insights.

What’s more, Russia may be steeling itself for the coming E.U. sanctions, said Michelle Wiese Bockmann, an analyst and markets editor at Lloyd’s List, a maritime information group in London. She said it may follow the model used by Iran and Venezuela, both sanctioned oil exporters that have used methods like reflagging older tankers and transferring cargoes from one ship to another at sea. Such shipping practices are legal but can obfuscate the source of cargoes.

“Sanctions are obviously foreign policy tools, but they are very blunt tools,” Ms. Bockmann said. “Whenever there are sanctions or restrictions or additional risk, there’s money to be made.”

Soaring natural gas prices haven’t attracted the same attention as higher prices at the pump. But that could change when the summer driving season ends and the winter heating season begins. The Henry Hub prices for natural gas, an industry benchmark, have risen to around $8 a million British thermal units from less than $4 at the start of the year.

Europeans have been cutting back on their purchases of Russian natural gas, which flows through pipelines. They have turned instead to buying more liquefied natural gas, which has been supercooled so that it can be shipped around the world in tankers. European L.N.G. imports from the United States rose to a record high in the first five months of 2022.

Exxon Mobil, which has invested in building an L.N.G. business along the Gulf Coast, is the largest holding in many U.S. energy funds. But despite calls to increase oil drilling and expand facilities for L.N.G. to offset sanctioned Russian oil and gas — which could ultimately lower commodity prices — Exxon and other energy companies are focusing on profitability, experts say, a practice the markets refer to as capital discipline.

“Capital discipline is still very much the watchword,” said John Maloney, the chairman of M&R Capital Management, a New York wealth management firm. “They are focused on reducing the company debt and returning profits to shareholders through stock buybacks.” Unlike in past oil booms, he said, “They’re not shifting to ‘Drill, baby, drill.’”

Mr. Maloney said he uses the Vanguard Energy exchange-traded fund when he wants to include energy in the portfolios he manages for clients. This $7 billion E.T.F. had a total return of 30.5 percent in the first half of the year, after a management fee of 0.1 percent. That return was driven in large part by the top two holdings, Exxon and Chevron, which combined made up 37 percent of the portfolio at the end of June. Exxon’s shares rose 42.8 percent in the first half of the year, while shares of Chevron rose 25.6 percent.

Despite the energy industry’s focus on returning profits to shareholders, Mr. Maloney said, he has begun trimming energy investments in some clients’ portfolios. “It’s not that we have a negative view of energy stocks,” he said. “But if something goes from being 3 percent of a portfolio to 8 or 9 percent, that’s a wonderful problem to have. But on a risk-adjusted basis, you might want to pare back that holding.”

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