What happened

Shares of oil drillers Occidental Petroleum (OXY 1.01%), Devon Energy (DVN 0.93%), and Diamondback Energy (FANG 1.00%) were falling more than the market on Monday. After each stock fell 5% in early trading, they recovered to declines of 2.4%, 3.5%, and 2.6%, respectively, as of 11:30 a.m. ET today.

The volatile energy sector got a double whammy of bad news this morning, as recent economic data out of both China and a part of the U.S. disappointed. And some believe a nuclear deal with Iran will happen soon, which would bring even more barrels onto the global market. As a result, oil prices fell some 4%, and are now lower than they were prior to Russia's invasion of Ukraine.

So what

On Monday morning, China's industrial production figures for the month of July rose 3.8%, well below economists' expectations of 4.5%. China has a goal of reaching 5.5% economic growth this year, but with the first half of the year coming in far below that, the country would have to do more than 5.5% to reach that goal. Officials in China have walked back on that rhetoric recently, and the situation doesn't look like it will improve very much, as long as officials continue to implement the country's "zero COVID" policies.

In addition, soft manufacturing data came in from the New York Empire State Manufacturing Index, which cratered by 42.4 percentage points to a negative 31.3 reading, signaling contraction in the region's manufacturing industry.

Obviously, soft economic and manufacturing data is seen as a headwind for oil demand. It looks like the tighter financial conditions implemented by the Fed from earlier this year are beginning to bite into economic growth.

At the same time, the status of the Iran nuclear deal is progressing, with the European Union negotiators asking for an answer on its draft of the deal by tonight. While the timeline for a deal has repeatedly been pushed back, it's possible a deal could come through in the near term -- although no one really knows if it will happen, with both sides playing it close to the vest.

In any case, weakening growth in the world's two largest economies along with the prospect of more Iranian barrels coming onto the world markets were enough to send oil prices retreating on Monday, down some 4% to $88 per barrel as of this writing.

Now what

Is this the beginning of a bigger downturn, or just a dip on the way to higher oil prices? It's really too difficult to tell in this crazy market, as the crosscurrents of tight supply but softening economic growth, especially in China, conflict with each other.

However, for those looking to abandon the sector, remember that the releases of 1 million barrels per day from the U.S. strategic petroleum reserve are expected to stop in October. In addition, the EU has agreed to ban the import of Russian crude by sea starting in December.

And the Chinese central bank cut a key lending rate today, in response to the soft manufacturing data. All of these factors could support oil prices. Perhaps that it why energy stocks are bouncing off their early-day plunge right now. 

Investment in oil exploration has been low for the past five years or so, and most oil companies have vowed to be more disciplined with capital spending. As such, the floor for oil prices might be higher than it was in the freewheeling growth-at-all-costs shale boom era.

It's probably best to keep a fixed percentage of one's portfolio dedicated to the energy sector, and rebalance that allocation depending on how energy moves in relation to the rest of the market.