Energy stocks have been caught in a downturn amid soaring inflation and a political desire within the White House to make oil and gas producers bend to consumer demand for cheaper fuel.
Do investors need to pay more attention to Washington?
Recent market action has been particularly disappointing for anyone who had bet that energy stocks would remain supported by strong global demand for oil and gas, and tight supplies.
The S&P 500 fell 5.8 per cent last week and energy stocks within the U.S. benchmark fared considerably worse: They slumped 17.2 per cent.
The Canadian energy sector also underperformed over this period and declined 5.4 per cent on Wednesday.
“While some of this has to do with fears of recession, there are concerns that the proposals being floated by the White House to lower prices of gasoline and diesel are too punitive for the energy sector,” Manav Gupta, an analyst at Credit Suisse, said in a note on Tuesday.
One of these proposals arrived on Wednesday: U.S. President Joe Biden called for a three-month suspension of federal gas and diesel taxes to provide relief from record-high prices.
“I fully understand that a gas tax holiday alone is not going to fix the problem,” Mr. Biden told White House reporters, “but it will provide families some immediate relief, just a little bit of breathing room as we continue working to bring down prices for the long haul.”
Efforts to lower prices at the pump come as inflation in Canada and the United States has soared to its highest level in nearly four decades. Central banks are now battling the surge with aggressive interest rate increases, including last week’s hike of three-quarters of a percentage point by the U.S. Federal Reserve.
Mr. Biden believes that energy producers are part of the problem here. High prices for crude oil and natural gas have generated fat profits for the sector, making it an easy political target.
A tax holiday, in theory, would lower the U.S. cost of gasoline by 18.4 US cents a gallon (24.4 US cents a gallon for diesel). That’s a reduction of less than 4 per cent and that’s only if the plan gains congressional approval.
What’s more, some observers expect that energy companies won’t pass along the full price reduction to consumers because of the current constrained supply of fuel.
“This is standard price incidence theory in economics – the government cannot decide who gets the benefits of a tax cut, it gets split between the two parties based on the responsiveness of supply and demand,” Jason Furman, a Harvard economist, tweeted on Tuesday.
Another potential political response to high gas prices: Impose a curb on U.S. crude oil exports, which would keep U.S. energy production at home.
This change would also require congressional support or, failing that, Mr. Biden could issue an executive order instead.
Either way, the effect might backfire, according to Mr. Gupta. He argued that if the United States stopped exporting oil, the global economy would suffer additional shortages at a time of tight supplies. Indeed, he expects the impact on global supply would be bigger than Russia’s invasion of Ukraine.
“This will cause global crude prices to move up significantly and prices of U.S. imported barrels will also go up with it,” Mr. Gupta said in his note.
A third political option is to tax the profits of energy companies, which have been directed largely toward debt repayment, share buybacks and dividend hikes this year.
But apart from strong opposition from energy-producing states, a so-called windfall tax might also further discourage energy companies from building much needed new projects to increase the output of oil and gas.
“If a key goal of the current administration is to have fossil fuel companies invest a lot of their cash flows back into business, raising corporate tax rate will have exactly the opposite effect,” Mr. Gupta said.
Perhaps investors should tune out the political threat, especially given that energy stocks are facing far more formidable obstacles.
Declining economic activity, which a number of economists expect will begin later this year, could crimp fuel consumption. Fed chair Jerome Powell added to the bearish chorus on Wednesday, when he told Congress that it was “certainly a possibility” of higher interest rates triggering a recession.
Even without one, high prices at the pump appear to be pushing consumers to drive less. The Wall Street Journal reported that gasoline sales at U.S. stations fell 8.2 per cent in the first week of June, compared with the same week last year.
In other words, so-called demand destruction may be kicking into gear.
Energy stocks are facing a political pushback. But the bigger threats have little to do with Washington.
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David Berman