What happened
Shares of energy stocks were falling broadly today. Even diversified blue chip names such as Chevron (CVX 0.57%) initially fell 2.4% in early trading before recovering to just a 0.7% decline as of 12:35 p.m. EDT. However, smaller-cap names that depend on the growth of the industry as well as the capital markets, such as rig equipment provider Transocean (RIG 2.24%) and early-stage natural gas and LNG play Tellurian (TELL -5.47%), were down much more significantly; they retreated in the high single digits this morning before slightly recovering to a 7.5% and 6% decline, respectively.
While the energy sector had been a big winner this year, it's hard for any commodity to withstand a severe global recession. And if you're a company that needs financing, good luck getting a reasonable interest rate today.
So what
While the world has mostly been fearing a supply crunch this year, high inflation is now spurring central banks around the globe to tighten monetary policy at a very rapid rate. That's causing lots of concern that the speed of interest rate hikes will lead to recession, higher unemployment, and lower oil and gas demand.
Oil prices weren't moving all that much, sitting at around $82 per barrel today, but natural gas prices, which had really been the big story of 2022, are down nearly 3% today and down by nearly a third since hitting yearly highs in mid-August. Furthermore, global commodities are priced in dollars, and a strong dollar will lower the price of oil and gas, all else being equal.
Today, the U.S. reported declining unemployment claims and revised upward second-quarter inflation data, showing a very strong -- and perhaps overheated -- economy. That stands in contrast with the rest of the world, as China's property bubble is bursting, the U.K.'s fiscal policy has led to a currency crisis, and Europe seems likely headed to a recession. The divergence is leading to a weakening of foreign currencies against the dollar at a historic pace.
The uncertainty has definitely hurt riskier oil and gas plays that depend on industry growth and are unprofitable at the moment. This is because spiking interest rates are also increasing debt costs, which threaten to put certain companies' businesses in jeopardy.
In fact, spiraling debt costs have already cost Tellurian dearly in just the past week. The company, which is aiming to build its Driftwood LNG plant, recently had to back out of a $1 billion debt sale it needed to continue funding the plant, as interest rate concerns caused buyers to demand a higher rate than Tellurian management would accept. While LNG is a hot commodity right now, Driftwood will also cost some $13 billion to build.
Unfortunately, the cancellation spurred Shell (SHEL 0.53%) to back out of its long-term agreement with Tellurian in response. Prior to the cancellation, Shell had agreed to purchase 3 million tonnes of LNG per year for 10 years when Driftwood became operational.
Transocean is falling today as well. Although the company reported modest operating income last quarter, it was still unprofitable on a net basis due to its high interest costs on its large debt load. In spite of some optimistic news, including the inking of a new contract for its Transocean Norge semisubmersible rig last week, the company's balance sheet certainly puts a lot of risk on the stock.
In fact, the company had to undergo a fairly dilutive refinancing earlier this month in order to retire some of its high-interest debt. That was actually a fairly smart move given the rapid rise in interest rates since then, but the company is still in a difficult situation. Oil companies are becoming more judicious with their capital expenditures even amid higher prices, so it might take another oil price surge for Transocean to move higher again.
Now what
There's a lot of global uncertainty right now, so it's no surprise to see investors moving to less risky stocks such as Chevron instead of unprofitable companies in industry niches, like Transocean and Tellurian. While Transocean and Tellurian have much more upside should the global economy stabilize and oil and natural gas demand follow, there is also a chance of bankruptcy or further dilution if things turn south.
Given all of the cross-currents out there, investors might want to stick with the defensive Warren Buffett-mirroring play of Chevron and other diversified majors in their oil and gas stock allocations for now.
