Oil Prices Have Dropped Sharply. Its Next Move Is Key.

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The price of oil has dropped significantly, and now faces a technical crossroads. Crude’s next move will be key for investors in both oil contracts and oil stocks. 

WTI crude oil

has fallen 9% to about $72 a barrel from its level just before the banking sector’s troubles emerged earlier this month. Those issues have stoked fears that lending, and therefore spending, will slow down, which would decrease demand for oil. 

Oil has also fallen by 41% from its peak of well over $100 hit in 2022. Initially, the Russia-Ukraine war had sent the price soaring, but since then, aggressive interest rate increases from central banks have dented demand. 

Now, the price of oil is around a key level. If it breaks below the low $70s area, it could open the door to more losses. If it can climb above this area, it could mean the commodity could remain on a larger uptrend since its early 2020 low. 

A move above the low $70 range would be “an initial sign it is bottoming,” John Kolovos, chief technical strategist at Macro Risk Advisors, wrote in a note last week.

The low $70 range is indeed a key technical point. Before this year, WTI crude hadn’t been at this level since late 2021. Back then, the price had been stabilizing in the area of $70 to $75 until Russia’s invasion of Ukraine issue sent it soaring in February 2022. A sustained move lower means oil could drop below the $65 area, the next range where buyers have entered in recent years. Another break below that range would leave the next key support level at around $40.

For oil stocks—as measured by an energy sector exchange-traded fund—to break a key support level, oil would have to experience a more-than-minor fall. 

The stocks are already trading with more strength than one might have assumed. The

Energy Select Sector SPDR ETF

(ticker: XLE) has fallen just 9% to about $79 from its level just before this month’s banking panic—right in line with oil’s drop. Theoretically, oil stocks should drop faster than the price of oil. That’s because producers have a lot of fixed costs, so when their sales fall alongside dropping oil prices, profits fall even faster. 

But oil stocks aren’t dropping more rapidly than the commodity because they’re already cheap. The ETF trades at about 9 times forward per-share earnings estimates, well below the midteens multiple seen various times in the past decade, according to FactSet. That’s why the ETF’s price might hold the line in the low $70 range or high $60 range, where buyers have tended to come in over the past couple of years.

Investors still have some baseline level of interest in buying oil stocks because the companies continue to return large sums of cash to shareholders, by way of dividends and buybacks.

Expected dividend and buyback dollars from

S&P 500

energy companies for the next year total roughly 10% of the sector’s aggregate market capitalization, according to 22V Research. That total cash-return yield is far better than the sub-4% yield on the 10-year Treasury note. As a result, oil companies would likely still return a fair amount of cash to shareholders, relative to their stock prices, even if the price of oil slips modestly and dents energy firms’ earnings. However, the price of crude needs to stay above the $65 area for cash returns to remain strong.

Energy investors will want to keep an eye on the price of crude. If oil cracks below its next support level, oil stocks likely would, too.  

Write to Jacob Sonenshine at [email protected]