What happened

Shares of major oil stocks such as ExxonMobil (XOM 1.22%), Occidental Petroleum (OXY 1.44%), and services provider Core Laboratories (CLB) were falling on Thursday, down 2.6%, 2.3%, and 3.7%, respectively, as of 2 p.m. ET.

Today marked a retreat after yesterday's strong gains, which were fueled by a news report that the Biden administration would consider refilling the Strategic Petroleum Reserve (SPR) should oil prices fall below $80 per barrel.

However, officials later poured cold water on that rumor. Meanwhile, the International Energy Agency (IEA) warned of weakening demand in the fourth quarter late Wednesday.

So what

On Wednesday, Bloomberg News reported the administration was considering refilling the SPR should oil prices fall below $80 per barrel. Oil stocks rallied yesterday, believing $80 represented a new "price floor." Most large U.S. operators can make lots of money at $80, as many of the large integrated companies and shale producers have declared their breakeven costs are well below $40 per barrel.

However, the Department of Energy later clarified that there was no specific price trigger and that refilling the SPR wouldn't take place until after fiscal 2023. Thus, it's no surprise to see oil prices retreating today.

Additionally, the IEA said China would see the biggest drop in oil consumption next quarter in more than three decades. Oil bulls can blame the Communist Party and its "zero Covid" policies, in which the government is enforcing strict lockdowns wherever it identifies a Covid outbreak. That has led to parts of or entire large cities going under lockdown at various times this year. When combined with China's real estate recession, consumer confidence, and therefore oil consumption, is quite low in China today.

Recession fears are also in the air for other developed nations as central banks raise interest rates across the world. This week, U.S. inflation data came in higher than expected, although producer prices, which more heavily track physical goods like commodities, were in-line. That could mean the Federal Reserve might raise rates aggressively to quell price increases in items like housing and medical care even as gasoline prices have already retreated significantly from their June highs.

Now what

Oil and gas stocks should remain highly volatile in this environment, as supply shock concerns are running headlong into fears of a potential recession, along with the uncertainty around China's Covid policies. Projections for next year's oil prices are all over the place, with some lower than today's price, while others are as high as $150 per barrel.

Warren Buffett seems to be guarding Berkshire Hathaway's (BRK.A -0.58%) (BRK.B -0.67%) portfolio against such a supply shock, as he has continued to gobble up Occidental shares this summer, with Berkshire now owning 26.8% of the company.

Nevertheless, oil and gas stocks could fall significantly should the economy go into a bad recession. But as of now, today's retail spending data report showed 0.3% month-over-month retail sales increases, so that doesn't seem to be in the cards just yet.

Investors should prepare for big moves in either direction; given how much energy prices affect the broader economy, some exposure is probably prudent for any diversified portfolio. Investors should probably decide on a fixed allocation to traditional energy stocks and keep that allocation fixed, culling positions on large gains and adding on big dips.

Another positive to owning oil and gas stocks is that most large producers are returning lots of cash to shareholders in the form of high dividends and share repurchases, so investors get paid for this "hedge" as well.