Earlier this year, around the time Nvidia Corp.’s market cap eclipsed that of the entire S&P 500 energy sector, I wrote about whether oil and gas stocks might offer a decent hedge when AI-fever breaks. The past several weeks have offered a test.
The good news for energy bulls is that the sector has acquitted itself well since early July, when Nvidia’s Magnificent Seven1 cohort, and the wider technology sector, peaked. The less good news is that things got complicated during the panic around the health of the labor market that kicked off in August.
Big Tech had gained 36% from the start of the year to July 10, with the Magnificent Seven notching 41%. Since then, tech has slumped by as much as 16%, while energy stocks held their own, outperforming the broader index.
It gets a bit murkier after that. Tech fell further on August 1, a Thursday, with chip makers such as Nvidia leading the way. But energy stocks, and crude oil, also slumped after factory gauges in both the US and China wobbled. It was a portent of what was to come when those US jobs numbers heard round the market dropped that Friday, sparking mentions of recession. Energy still beat tech through the first eight days of trading this month, but also sank and lagged the S&P 500.
Once the narrative shifted from AI-is-overhyped to it’s-the-economy-stupid, cyclical oil stocks buckled. The re-emergence of US recession risk comes at a particularly delicate time for the energy sector. First, China’s economy is struggling. Having jumped by 1.4 million barrels a day in 2023, Chinese oil demand is projected by the International Energy Agency to rise by just 300,000 barrels a day in 2024 and not by much more in 2025. Even OPEC finally trimmed its peculiarly high forecast for global demand this week.
Speaking of oil cartels, the second problem concerns OPEC+. Its supply cuts support oil prices, but they also create an overhang of spare capacity: 5.5 million barrels a day in July according to IEA estimates, equivalent to 5.3% of global demand or, put another way, the entire current output of Iran and Libya, plus Venezuela.
In a strong oil market, that sort of overhang caps rallies. But in a weakening one, it leaves OPEC+ looking rather like a central bank with interest rates already at zero. If recession hits, you don’t have another lever to pull. As it is, oil prices aren’t high enough to cover Saudi Arabia’s fiscal deficits. If big economies slip into recession late this year or next, cutting OPEC+ supply even further could mean a combination of less market share and lower prices, meaning less cash flowing into petrostate treasuries. At least some members probably wouldn’t stick to targets in that scenario, weighing on prices further.
“If you like tech, it’s hard to like energy. If you’re fearful of the economy, it’s also hard to like energy,” is how Dan Pickering, chief investment officer at Houston-based Pickering Energy Partners LP, sums up the vibe shift in August.
Overall, though, energy stocks have performed well as a hedge over the past month or so. And while the risk of a US recession is up, it isn’t the base case. Nor is it the only risk out there, given expectations of an imminent Iranian attack against Israel, potentially sparking a wider conflict and oil-price spike, especially given how short speculative positioning in futures has gotten.
Big Oil has cleaned house over the past five years, eschewing growth for capital discipline and consolidating. As Pickering puts it: “The days of energy being 12% of the market and a fund manager owning 15 names are over. That fund manager owns three names today.” As it stands, though, tech has picked back up and the S&P 500 is less than 3% away from its all-time peak. Even after selling off, Nvidia’s market cap is now 79% bigger than the entire energy sector. Energy has shown it can act as a hedge against tech unless economic weakness takes center stage. The market considers chips to be the currency of the future. It’s a sustained adjustment in that attitude, glimpsed last month, that energy stocks could really use.
1 In addition to Nvidia, the Magnificent Seven include Microsoft Corp., Apple Inc., Amazon.com Inc., Meta Platforms Inc., Tesla Inc. and Alphabet Inc.
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