What happened
Shares of energy stocks fell sharply today. Even diversified blue chip names such as Chevron (CLC -1.12%) initially fell 2.4% in early trading before recovering from a decline of just 0.7% as of 12:35 p.m. EDT. However, smaller cap names that depend on industry growth as well as capital markets, such as the drilling equipment supplier Transocean (PLATFORM -9.71%) and natural gas and LNG at an early stage earthling (TO TELL ABOUT -6.93%), fell much more significantly; they retreated into the high numbers this morning before recovering slightly to declines of 7.5% and 6%, respectively.
Although the energy sector has been a big winner this year, it is difficult for a commodity to withstand a severe global recession. And if you’re a business that needs financing, good luck getting a reasonable interest rate today.
So what
While the world mainly feared a supply crisis this year, high inflation is now prompting central banks around the world to tighten monetary policy at a very rapid pace. This raises many concerns that the speed of interest rate hikes will lead to a recession, higher unemployment and lower demand for oil and gas.
Oil prices weren’t moving much, sitting around $82 a barrel today, but natural gas prices, which had really been the big story of 2022, are down almost 3% today and by nearly a third since hitting yearly highs in mid-August. Additionally, global commodity prices are in dollars, and a strong dollar will lower the price of oil and gas, all else being equal.
Today, the United States announced a drop in jobless claims and revised inflation data for the second quarter upwards, showing a very strong – and possibly overheating – economy. This contrasts with the rest of the world, as China’s housing bubble bursts, UK fiscal policy has led to a currency crisis and Europe appears to be heading into recession. The divergence leads to a weakening of foreign currencies against the dollar at a historic rate.
The uncertainty has definitely hurt the riskier oil and gas sectors that depend on industry growth and are currently unprofitable. Indeed, soaring interest rates also increase the cost of debt, which threatens to jeopardize the activities of some companies.
In fact, soaring debt costs have already cost Tellurian dearly over the past week. The company, which aims to build its Driftwood LNG plant, recently had to forgo a $1 billion debt sale it needed to continue funding the plant, as interest rate concerns pushed 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 0.33%) to walk back his long-term deal 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 also down today. Although the company reported a modest operating profit last quarter, it was still not profitable on a net basis due to its high interest charges on its large debt load. Despite some upbeat news, including the inking of a new contract for its semi-submersible rig Transocean Norge last week, the company’s balance sheet certainly poses plenty of risk to the stock.
In fact, the company had to undergo a fairly dilutive refinancing earlier this month in order to pay off some of its high-interest debt. It was actually a pretty smart move considering the rapid rise in interest rates since then, but the company is still in a tough spot. Oil companies are getting smarter with their capital spending, even amid higher prices, so it may take another spike in oil prices for Transocean to go back up again.
Now what
There’s a lot of global uncertainty right now, so it’s no surprise to see investors turning to less risky stocks like Chevron instead of unprofitable companies in industry niches, like Transocean and Tellurian. While Transocean and Tellurian have a lot more upside if the global economy stabilizes and demand for oil and natural gas follows, there’s also the risk of bankruptcy or further dilution if things go south.
Given all the cross-currents, investors may want to stick to the defensive play of Chevron and other diversified majors, mirroring Warren Buffett, in their oil and gas stock allocations for now.
Billy Duberstein has no position in the stocks mentioned. Its clients may hold shares in the companies mentioned. The Motley Fool recommends Transocean. The Motley Fool has a disclosure policy.