What happened
Shares of smaller-cap energy-sector names Tellurian (TELL 7.87%), Kosmos Energy (KOS 0.94%), and NexTier Oilfield Solutions (NEX) fell hard on Wednesday, down 16.4%, 9.2%, and 6.5%, respectively, as of 2:03 p.m. ET. The broader markets were slightly higher at that time, making the decline in these names -- and energy stocks more broadly -- even more pronounced.
Several forces worked against energy stocks Wednesday. First, crude oil prices were down about 3% as of this writing as investors anticipated that an economic downturn would result from more aggressive Federal Reserve interest rate hikes. While the price of natural gas was flattish, it too was well off the high it touched earlier this month. Additionally, President Joe Biden has summoned the heads of the leading oil companies to the White House for a meeting Thursday, and some expect that pressure from Washington might lead to new supply coming online faster.
So what
Last week, following the Federal Open Market Committee's largest single-step hike in the federal funds rate since 1994, oil prices started dropping, and energy stocks plunged with them. U.S. benchmark West Texas Intermediate crude is now between $106 and $107, down from about $123 per barrel prior to the rate hike. Meanwhile, natural gas futures have decreased to around $6.83 from highs around $9.30 earlier this month. The thinking among energy investors appears to be that a recession would reduce oil demand, sending prices down. Moreover, since oil is priced in dollars and higher U.S. interest rates strengthen the dollar's value, they also tend to suppress the price of oil.
While the demand outlook remains a question, the Biden administration is strongly looking to ramp up supply. Oil executives will meet at the White House Thursday with Energy Secretary Jennifer Granholm, and that session could possibly lead to a deal under which they would increase output, refinery capacity, or both. Could such an agreement lead to more supply hitting the market just as demand begins to wane? Clearly, oil bulls are worried about such a scenario.
All these stocks are sensitive to the prices of oil and natural gas. Tellurian is perhaps the most volatile of the three because its main asset is its Driftwood LNG plant, which is under construction and won't come online until 2026. Tellurian also owns a small number of natural gas wells, but it is still generating losses as the costs of constructing the Driftwood plant continue to exceed its revenues. Rising interest rates also aren't doing any favors for Driftwood's financing costs.
Kosmos is a more traditional oil exploration company, specifically centered on proven deepwater assets in Atlantic Ocean basins in Africa and the Gulf of Mexico. NexTier is a fracking equipment supplier with a business centered on U.S shale basins from the oil-rich Permian in the Southwest to the Marcellus Shale in Pennsylvania and West Virginia.
Tellurian is a more speculative investment since its earnings potential is far out in the future and therefore more uncertain, so it's probably most sensitive to the movement in oil and gas prices and their future outlook. Kosmos is the next most sensitive, as it is a price-taker for its current oil volumes. NexTier, by contrast, is down less than the others -- perhaps because that White House meeting could lead to energy companies making an effort to increase oil and natural gas supply. That would mean an increased need for frack rigs, and thus more sales for NexTier. However, NexTier is still influenced by the overall outlook for oil and gas prices, which explains why its shares fell as well.
Image source: Getty Images.
Now what
Energy had been the lone strong sector on the market this year, but it entered its own bear market following the Fed's latest interest rate hike. It's difficult to predict if there will be another spike in energy prices, a crash back down to the levels seen prior to Russia's invasion of Ukraine, or sustained prices in the current high range. There are just too many variables, considering the current supply-and-demand imbalance, global supply chain issues, the ambiguous state of the U.S. economy, the war in Ukraine, and the outcome of the major energy companies' negotiations with the Biden administration.
If you are investing in energy companies, make sure the stocks you chose are aligned with your risk tolerance, and perhaps look to keep a fixed allocation to the sector in your favorite names. If energy starts to outperform again, you can pare back your holdings, and if it underperforms, you can increase your holdings to keep the allocation steady. The energy sector is highly volatile, so perhaps keeping an allocation percentage as your North Star would be the best way to go.
