What happened
Energy stocks dropped big on Tuesday as the price of U.S. benchmark crude oil slid by more than 8%, pulling the entire industry lower. The price of oil was falling on renewed fears that there will be a recession that cuts into demand.
Diamondback Energy (FANG -0.01%) fell as much as 5.7%, Transocean (RIG -2.69%) was off by as much as 6.8%, Occidental Petroleum (OXY -0.05%) at its low was down 6%, and Core Laboratories (CLB) plunged by 7.7%. At the close, their shares were down 3.5%, 6.1%, 3.6%, and 6.3%, respectively. These are a broad range of companies, from explorers to suppliers to the industry, so you can see that the impact on oil stocks is widespread.
So what
The price of West Texas Intermediate crude oil fell 8.2% to $95.56 in trading Tuesday, while Brent crude was down 7.5% to $99.03. When the price of oil falls, it's natural for stocks that rely on that commodity to drop as well.
Investors are worried that lockdowns in China will reduce oil demand just as producers are starting to slowly increase supply. In the U.S., both production and oil drilling rig activity have been generally increasing since the depths of the pandemic slump, when oil prices went negative for a short time.
US Crude Oil Rotary Rigs in Operation data by YCharts
In China, the cities of Xi'an, Lanzhou, and Haikou have already put partial lockdowns and restrictions in place in a bid to prevent more COVID-19 outbreaks, and the gambling hub of Macao has shut down its casinos and other nonessential businesses. There are concerns that bigger cities may soon go back into lockdown again, too. In the city of Shanghai, a major Chinese manufacturing center, new COVID-19 cases have been found, and the country continues to pursue a "zero COVID" policy. China is the second-biggest oil consumer in the world, accounting for 13.2% of global demand.
Now what
Oil prices have been elevated since before Russia invaded Ukraine, and shot even higher in the wake of that event, but that doesn't mean the uptrend was expected to continue indefinitely. The futures market has been in what's called backwardation for months, meaning that future prices for oil have been lower than the spot prices that are often quoted by the media. Put another way, traders have been betting that oil prices would drop.
Tuesday's oil price move seems to be something that has been anticipated for some time, although the specific catalyst that would cause it wasn't known in advance. What I'll be watching over the next few weeks is how demand in China is hampered by lockdowns and restrictions there. When oil prices went negative in 2020, it wasn't because supply changed, it was because demand dropped dramatically.
This isn't going to be a global shutdown, but even a 3% to 4% decline in global demand would be a big deal for oil markets. Oil companies, on the other hand, are along for the ride, and right now, investors have to be happy that they haven't increased production too much in 2022, which would have led to a supply glut.
