Why Oil Prices Have Crashed – And What Investors Should Do Now

It was only a month ago that I began advising investors to ease up on certain energy stocks, following 20%-30% gains since the beginning of the year. But a brutal May and a weak start to June have sent oil prices — and some energy companies — back into bear market territory.

The front-month West Texas Intermediate (WTI) crude contract ended May over 16% lower, which marked the first monthly loss of the year. What has happened, and is this now a buying opportunity for energy stocks?

What’s Driving Oil Price Down

There are two bearish factors weighing down oil prices. The first is that it is becoming apparent that the trade war with China will be lengthy. There are fears that this will impact oil demand there as well as here.

Add last Friday’s announcement by the Trump administration of plans to impose a 5% tax on all goods imported from Mexico unless “the illegal migration crisis is alleviated.” These tariffs would potentially rise to 25% by October. This sent a chill through the stock markets and the oil markets, with WTI losing more than 5% on the day.

The global oil demand picture has been mixed in recent months. The International Energy Agency (IEA) reported that oil demand numbers for the January-February period in China grew by 410,000 barrels per day (BPD) year-over-year. India’s demand grew by 300,000 BPD, and U.S. demand was close behind with 295,000 BPD of growth.

But oil prices impact demand, and they have risen sharply since January. This, along with the trade war, may explain more recent reports that overall oil demand in China had declined by 0.3% year-over-year in the first quarter.

That brings me to the second factor that I believe is impacting the oil markets. Every time demand in China slows down, there’s a rush to push the narrative that it’s because electric vehicles (EVs) are finally starting to take a bite out of oil demand.

This explanation promotes the fear that crude oil will soon end up like coal, which in turn helps push oil prices lower than they should be. Bloomberg recently projected that oil demand in China will peak in 2025 as a result of EVs.

Thus, there is a fear premium in that investors don’t want to be left holding a worthless commodity. I think such fears are premature. In fact, the current weakness in oil prices is totally out of sync with geopolitical factors in Venezuela and Iran.

Investment Outlook

Let’s consider a few things. First, Bloomberg also recently reported that energy stocks now account for only 5.02% of the S&P 500, which is less even than in early 1999. Notably, at that time oil prices had collapsed to $10/bbl and the tech bubble was depressing the share of all other sectors.

Consequently, a 5% energy share today is a significant historical disconnect. In other words, energy stocks are again undervalued relative to history (except those who believe we are now at the end of the oil age).