Oil stocks are acting like the top is in for one-time hottest trade of 2022

Published Thu, Aug 4 20229:40 AM EDT

On the surface, it looks like a golden age for oil companies. Oil is up over 60% in the second quarter against one year ago. Oil company profits are through the roof, expected to increase 142% this year alone. But Energy stocks are acting like this may be the top. Oil and gas names topped out in June just as crude oil peaked, and are now 20% off their highs. Lately, traders have been selling off oil stocks under the theory that profits in 2023 will likely be lower than 2022, not higher. Oil company profits: a top? (2023 earnings ests. vs. 2022) Occidental Petroleum - 22% ExxonMobil - 15% Chevron - 9.4% Indeed, oil analysts as a group expect Energy sector profits to decline 12.8% in 2023, one of only two sectors (the other is Materials, also a commodity sector) whose earnings are expected to weaken next year. The reason: the primary determinant of oil company profits are oil prices, and estimates for oil are coming down. For much of 2022, oil has been in "backwardation": futures prices for the most immediate contracts have been higher than prices farther out. That pattern is only accelerating into 2023. While spot oil is currently roughly $91, futures prices for 2023 average closer to $84. Oil futures contracts August: $90.95 December: $87.88 Feb. 2023: $86.22 April 2023: $84.83 June 2023: $83.26 August 2023: $82.41 Why are oil price estimates declining? "The key wildcard, in our view, is risk of a steep recession, which could imperil oil demand and, thus, those commodity price forecasts," Stewart Glickman from CFRA said in a recent note to clients. The bottom line: stocks don't usually go up when forward earnings estimates are going down. The market seems to be pricing in a peak in oil fundamentals in the first half of 2022. Are huge buybacks and dividends enough to keep investors? The industry is frantically returning oceans of cash to shareholders to keep them from divesting. Pioneer Natural Resources, for example, raised its dividend 40% yesterday and now boasts a dividend yield close to 8%. Energy stocks, which are only 4% of the S & P 500 by market capitalization, are expected to contribute 10% of the dividends in the second quarter, according to S & P Global. Buybacks are also increasing rapidly. Exxon has tripled its share buyback to $30 billion through the end of next year. Chevron already has bought back $4 billion and raised the upper limit to $15 billion. Shell just announced a $6 billion buyback over the next three months alone. BP expanded its quarterly buyback by $2.5 billion beginning in 2Q 2022. Why the buyback surge from oil companies? "I would argue they are buying back shares because they can't find any reasonable investments in an environment that is moving away from fossil fuels," energy analyst Andy Lipow told me. "Do not get me wrong, they are increasing some amount of spending on production and new sources of energy, but they are simply drowning in cash and getting it to their shareholders," he said. Bulls are cheering the drop in Energy No one cheering for stocks to rally are crying over the drop in oil, or the drop in oil stocks. "The whole narrative of the Fed pivot [that the Fed will finish raising rates by the end of 2022] works better with oil falling," Alec Young, chief investment strategist for mapsignals.com, told me. "The market is telling you growth is slowing," Young said " It doesn't particularly want deep value stocks, like oil. It wants all-weather growth stocks that can grow in any environment." Which is why Technology stocks have led the rally since the June 16 bottom.