Latest / Energy Economics with Fexingo: Oil Prices, Renewables, and the Cost of Power / Why Oil Stocks Are Plunging Faster Than Crude Itself
Transcript
- Lucas: Crude oil is down about five percent this week. WTI sits just above seventy-six a barrel as of this afternoon. And energy stocks? They're getting hammered even harder. Luna: Yeah, I was looking at the numbers. ExxonMobil down more than six percent, Chevron down over seven, ConocoPhillips nearly eight percent. That's a much bigger drop than the underlying commodity. Lucas: Right, and that's the puzzle I want to unpack today. Normally oil stocks track crude pretty closely. When WTI drops five percent, you expect the XLE energy ETF to be down maybe four or five percent. But this week the gap is two to three percentage points wider. Something else is going on. Luna: So is the market pricing in something that hasn't hit the spot price yet? Like a lower for longer scenario? Lucas: Exactly. And I think there are two concrete forces at work here. First is refining margins — they've been compressing hard. The crack spread, which is the difference between crude oil and the refined products like gasoline, has narrowed significantly. So even if crude stabilizes, the profits that refiners and integrated producers make from turning oil into fuel are shrinking. Luna: And that hits companies like Exxon and Chevron directly, because they have massive refining operations. Lucas: Precisely. Exxon's refining segment has been a huge profit driver the past couple of years. If that piece of the business starts earning less, the stock re-rates. And that's exactly what we're seeing. The second force is the macro picture. The Fed, under new Chair Kevin Warsh, is signaling that rates will stay higher for longer to get inflation down. That's a headwind for economic growth, which means oil demand expectations get marked down. Luna: And the market is forward-looking. Stocks trade on expectations for the next twelve to eighteen months, not just today's barrel price. Lucas: Right. So the stock market is effectively saying: 'Yes, crude is at $76 today, but we think it's going to average lower over the next two years because of slower demand and potentially more supply if the Iran deal goes through.' Meanwhile, the oil futures curve is still backwardated, which means near-term barrels are more expensive than future ones. That backwardation is a sign of tight supply today, but the equity market is looking past that. Luna: Let's talk about the Iran deal specifically. There are headlines today about Vance leading peace talks in Switzerland, and Trump threatening fresh strikes. The uncertainty alone is probably weighing on the sector. Lucas: Yeah, it's a classic wait and see situation. If a deal is reached, Iranian oil could come back onto the market pretty quickly — maybe one to one point five million barrels per day within six months. That would be a meaningful supply increase at a time when demand growth is already slowing. The equity market is effectively pricing in a higher probability of that scenario than the crude futures market is. Luna: So the stocks are incorporating a risk premium that the commodity isn't. That makes sense because stocks have a longer duration — they're a claim on a stream of future cash flows, whereas a barrel of oil today is just a barrel today. Lucas: That's a really good way to put it. And this isn't the first time we've seen this divergence. Back in late 2014, when OPEC decided not to cut production, oil prices collapsed and energy stocks got cut in half. But the stocks actually led the downside — they started falling before crude did, because the market anticipated the glut. Similarly, in early 2020 during the pandemic, energy stocks had already dropped twenty-five percent by the time WTI went negative. Luna: So the equity market acts like a leading indicator for the oil market. What about the natural gas side? Henry Hub is basically flat this week at around three dollars and six cents per million BTU. But some of the big diversified producers also have gas exposure. Lucas: Good point. Natural gas isn't moving much, but it's also not providing a cushion. Companies like ConocoPhillips have significant gas production, and if gas prices stay range-bound, there's no upside there to offset weakness in oil. And the forward curve for gas is also flat to slightly lower, so no relief on that front either. Luna: Let's look at the clean energy side. The iShares Global Clean Energy ETF is actually up a bit this week, about one percent. That's interesting given the broader sell-off in energy. Lucas: Yeah, ICLN up a percent, while the oil and gas ETF is down over six. That's a rotation trade. Some investors are saying, 'If oil is going to be lower for longer because of a demand slowdown and potential supply surge, maybe I should move money into renewables, which have a different catalyst — government policy, AI data center power demand, and long-term decarbonization.' I think that's part of it. Luna: But even within clean energy, it's not all rosy. The solar ETF TAN is down almost four percent this week, and Enphase Energy is down over four percent. So it's not a blanket rotation. Lucas: No, it's selective. The rally in clean energy is really concentrated in utilities and grid infrastructure — names like NextEra Energy, which is up almost a percent this week. NextEra is seen as a steady-growth utility with a huge renewable build-out. But solar manufacturers and residential solar installers are struggling with high interest rates, which make financing more expensive for homeowners. Luna: So the market is making nuanced bets: long on regulated utilities with renewables, short on upstream oil, and cautious on downstream refining. It's not a simple 'oil bad, solar good' story. Lucas: Exactly. And that's what makes this such a fascinating moment. The energy sector is fracturing along sub-sector lines in a way that tells you a lot about where investors think the economy is headed. If you believe the Fed is going to succeed in slowing growth to tame inflation, then oil demand weakens, refining margins compress, and the whole integrated model gets squeezed. But utilities — especially those with regulated returns — become more attractive because their earnings are less cyclical. Luna: It's almost like a defensive rotation within energy itself. You're moving from the cyclical parts to the more stable ones. Lucas: Right. And I think there's one more layer here that's worth digging into. The ten-year breakeven inflation rate, which is a market-based measure of expected inflation, is at two point two five percent. That's down slightly from last week. So inflation expectations are moderating, which gives the Fed room to eventually cut rates. But the timing is uncertain. The market is pricing the first cut maybe in early 2027. That 'higher for longer' narrative is what's really hitting energy stocks. Luna: If you're an energy CEO, how do you plan capital spending in this environment? Do you keep investing in new production, or do you return cash to shareholders? Lucas: Most of the majors have already signaled that they're prioritizing shareholder returns through dividends and buybacks over aggressive production growth. That's been the theme since 2021. And it's the right move if you think the long-term demand picture is uncertain. But it also means that when the stock price falls, the yield goes up, and that can attract value-oriented investors. So there's a floor of sorts. Luna: Speaking of shareholder returns, let's talk about the valuation question. After this week's drop, the XLE is trading at about ten times forward earnings. That's cheap by historical standards. Is the market overreacting? Lucas: It could be. But if earnings are about to drop because of lower oil prices and weaker refining margins, then a ten times multiple might not be that cheap. Forward earnings estimates are likely to get revised down. So the question is whether the stock price has fallen enough to compensate for the expected earnings decline. I don't think we know the answer yet. We need to see how the Iran situation resolves and what the next CPI print looks like. Luna: The next CPI is due in a couple of weeks. The May reading showed core CPI at three point three six percent year-over-year, still above the Fed's target. If that number stays stubborn, the 'higher for longer' narrative gets reinforced, and energy stocks could have further to fall. Lucas: Absolutely. And conversely, if we get a softer inflation print, the market could rally on rate-cut hopes, and energy stocks would likely bounce — though maybe not as much as the broader market, because the oil demand story would still be murky. It's a tough spot for the sector. Luna: So what's the one thing our listeners should watch over the next month to gauge where energy stocks are headed? Lucas: I'd say watch the brent wti spread, which is currently around four dollars. That's a bit wider than normal. It usually reflects transportation costs and quality differences. If that spread narrows, it could signal that global supply concerns are easing. Also, watch the weekly inventory reports from the EIA. If we start seeing builds in crude inventories, that's a bearish signal for the commodity and a further headwind for stocks. Luna: And on the geopolitical side? The Vance talks in Switzerland? Lucas: That's the wild card. If there's a breakthrough, oil could drop another five dollars overnight, and energy stocks would gap down. If talks collapse, we could see a relief rally. But given the current trajectory, the market seems to be pricing in some probability of a deal. The stocks are reflecting that pessimism more than the commodity is. Luna: That's a great summary. It feels like the next few weeks are going to be pivotal for the energy sector. Lucas: They really are. And we'll be tracking it closely here on the show. If you find the way we walk through the economy helpful, I just want to mention something quickly. Luna: Yeah, go ahead. Lucas: We deliberately keep this podcast free of ads. No sponsors, no interruptions. If you want to support that choice, the simplest way is to buy us a coffee — literally, at buy me a coffee dot com slash fexingo. It helps us keep doing what we do, no strings attached. Luna: It's a small gesture that goes a long way. And we genuinely appreciate it. Lucas: Alright, back to the oil markets. So where do we think this goes from here? Let's look at the options market. The implied volatility on oil futures is elevated — the vix equivalent for oil is well above its historical average. That tells you the market expects big moves, but it's not sure which direction. Luna: So we're in a waiting game. The data and the headlines will determine the path. Lucas: Exactly. And in the meantime, energy stocks have become a battleground between value investors seeing a buying opportunity and momentum traders fearing further downside. It's a fascinating dynamic. Luna: Well, we'll keep an eye on it. Thanks for joining us on Energy Economics with Fexingo. Lucas: Talk to you next time.