Energy Stocks Are Hot. What’s Ahead.

There’s also a disconnect between oil stocks and the commodity, and that points to underlying problems. Brent crude futures, the international benchmark, were trading around $96 on Thursday, up 27% since the end of June, while the
SPDR S&P Oil & Gas Exploration & Production ETF
(ticker: XOP) is up 17% in the same period.

One reason the stocks have lagged behind the commodity, and may continue to, is that traders expect oil prices to be lower next year. Brent crude futures expiring a year from now are trading around $84 per barrel, $12 below current prices. Oil stock gains are thus “tempered by a backwardated price structure where the long-dated price is the only barometer of what the market will discount,” wrote Bank of America analyst Doug Leggate. The term “backwardated” describes a market where near-term prices are higher than prices in the future.

Oil prices right now are being lifted by Russia and Saudi Arabia, which have announced they will cut production through the end of the year to keep prices high. Both countries could continue to keep their production low next year, but there’s also a chance they’ll start producing more, thereby causing downward pressure on prices. “While oil above $90 is clearly positive for near-term sector free cash flow, longer dated prices depressed by a spare capacity overhang remains a tangible headwind to valuations,” Leggate wrote.

In addition, some analysts expect oil demand to get weaker.

“Demand risks are shifting to the downside: With pump prices surging and a seasonal travel peak now behind us, a greater share of demand in the fourth quarter will be concentrated in sectors more sensitive to economic growth,” wrote Natasha Kaneva, head of the global commodities strategy team at
J.P. Morgan,
in a note last week. “We already observe some tangible slack in demand.”

Among the areas where Kaneva sees demand slipping are U.S. gasoline and jet fuel. “Signs abound that domestic air travel demand, which had been relatively unfazed by the slowdown in discretionary spending, may have peaked as cash-strapped consumers book fewer trips,” she wrote. “After a summer season that saw record numbers of travelers, U.S. airlines are now reporting sales at the lower end of expectations and below historical seasonality patterns.”

If oil prices stall, Exxon (XOM) and its peers will need other levers to pull for their stocks to rise. Some analysts think the company’s chemicals and specialty products business—higher-value substances made from petroleum or biomass—could be one of those levers. Jefferies analyst Lloyd Byrne upgraded his price target to $140 last week, up 18% from recent prices, because those areas could provide a new spark.