Oil stocks have posted strong gains so far this year but have slipped in recent trading sessions, and analysts at Bernstein say the same drivers behind the rally could now push the sector lower.
Analyst Bob Brackett highlighted three main factors that typically lead to declines in oil-related equities.
“Oil-linked equities have risen year to date for three reasons: overall beta to oil price, sector rotation, and geopolitical risk premia,” Brackett wrote.
“Oil-linked equities similarly fall when: (1) the cost of oil is too high, inducing demand destruction, (2) sector rotations end, and (3) geopolitical risk premia fall.”
The first potential trigger—demand destruction—does not appear imminent. Bernstein noted that crude prices remain below levels that have historically caused significant economic pressure.
Brackett explained that oil market cycles tend to reach their peak when energy costs account for roughly 6% of global GDP, adding that “we are well below such levels today.”
“If the cost of oil exceeds 5% (again we are closer to 4%), then the price of oil one year forward is nearly always negative (and of course oil equities follow),” the analyst said.
Another factor is sector rotation. Bernstein noted that part of the recent strength in energy shares has been driven by investors reallocating capital away from technology stocks.
“Worries about the role of AI have driven flow from software into an oil sector which felt less assailable and had a reasonable entry point at lower oil prices,” Brackett wrote. “Given the overall lack of upside across names in our sector, we’d argue it’s a potential risk for the rotation to reverse.”
Finally, oil stocks could also weaken if geopolitical tensions ease. According to Bernstein, the risk premium tied to global conflicts may remain in place for weeks or even months, but a lasting resolution would likely remove an important support for the sector.