Crude awakening for earnings season

Over the past year, energy markets have had to deal with significant uncertainty, primarily driven by the macroeconomic backdrop, the fractious geopolitical landscape, and the idiosyncrasies of the oil market. Oil appears stuck in crosscurrents ranging from cuts to production to uncertainty over global demand as sanctions loom large over Russian oil exports. For example, on October 5, OPEC+ stated they would cut production by two million barrels per day due to “uncertainty that surrounds the global economic and oil market outlooks.” As winter approaches, increasing oil price volatility will likely raise gas prices for consumers. As a result, the U.S. extended its drawdown of the Strategic Petroleum Reserve (SPR), bringing the country’s crude oil inventory to its lowest level since 1984.

Further complicating the turmoil in energy markets is an already low level of ultra-low sulfur diesel. Per the U.S. Energy Information Administration (EIA), U.S. distillate fuel oil inventories have been below the five-year low (2017–2021) since the start of 2022, primarily driven by less global refining capacity. Uncertainty across commodity markets can also be viewed through valuations, earnings, and profitability metrics. For example, the earnings power of the energy companies has been impressive this year. For Q3 of 2022, 81% of energy companies reported earnings above analyst expectations. Furthermore, excluding the energy sector’s contributions, year-over-year earnings growth in Q3 for S&P 500® firms is -3.4% per Refinitiv, compared with a 4.3% growth rate with energy earnings included. The energy sector also has the highest earnings growth rate (140.6%) for Q3 of 2022.

With supply constraints and underinvestment restricting new energy production, it’s no wonder the S&P 500 Energy Index flaunts a year-to-date total return of approximately 74%, compared to the -19% year-to-date loss for the S&P 500. Investors must also consider the long-term implications of reducing the Strategic Petroleum Reserve, as large supply cuts from OPEC+ and sanctions on Russian oil exports will reduce output in the coming months. Nevertheless, with the SPR at levels not seen since the 1980s and geopolitical headwinds likely to persist, energy companies should continue to see their earnings rise for the foreseeable future, rewarding investors with exposure to the energy sector.