The IEA Just Revised Oil Demand Down by 420,000 Barrels a Day. Is It Time to Trim Your Energy Stocks?

Oil prices have skyrocketed this year due to the war in Iran and its impact on oil supplies from the Middle East. Brent oil, the global benchmark price, has rocketed by about 80% this year to around $110 a barrel.

The surge in crude prices is starting to affect global oil demand. The International Energy Agency (IEA) recently revised its demand outlook down by 420,000 barrels per day. Here's a look at whether this demand destruction means it's time to trim your energy stocks.

Image source: Getty Images.

A drop in the barrel

Heading into this year, the IEA expected that global oil demand would fall by about 80,000 barrels per day due to slowing economic growth. It also expected an abundance of supply. These factors fueled the consensus that oil prices would be lower this year. For example, JPMorgan had a bearish outlook for Brent, expecting it to average around $60 a barrel this year.

The IEA now expects oil demand to fall by 420,000 barrels per day, driven by demand destruction from surging crude prices. While that's a meaningful amount, it's just a drop in the bucket compared to the supply shortfall caused by the Strait of Hormuz closure. Oil production across the Middle East has fallen more than 50%. For example, Iraq's oil output has plunged from 4.9 million barrels per day before the war to around 1.6 million barrels per day. Overall, the supply loss is well over 10 million barrels per day, which countries are covering by withdrawing oil from global inventories. The cumulative loss exceeds 500 million barrels and continues to grow by the day.

The two headwinds to a recovery

The oil market will take a long time to recover from this supply shock once the Strait of Hormuz reopens, with the recovery period extending the longer it remains closed. One issue hindering a return to normal will be the time needed to restart oil wells that oil companies had to shut in as above-ground storage terminals reached capacity. For example, Woods Mackenzie estimates it will take some of Iraq's southern oil fields nine months to get back to 85% of their prewar production level.

The other issue is the need to rebuild global oil inventories, which will take even more time. For example, IEA member countries are releasing 400 million barrels from their emergency stockpiles, which they'll need to replenish once the supply picture improves.

These factors suggest that oil prices will likely remain elevated long after the Strait of Hormuz reopens. Goldman Sachs' base case is that Brent will average $90 a barrel during the fourth quarter. That assumes Persian Gulf exports normalize by the end of June. Crude prices will likely remain elevated well into 2027 as the market slowly recovers.

The base case is a bull case for energy stocks

While higher oil prices are creating some demand destruction, consumption remains well above supply. That trend could persist for months even after the Strait of Hormuz reopens, suggesting crude prices will remain high. That's bullish for oil stocks.

Despite that bullish base case, oil stocks haven't rallied as much as you'd expect. For example, oil giants Exxon (NYSE: XOM) and Chevron (NYSE: CVX) are only up around 25%-30% this year. That suggests they could have further to run if crude prices remain higher into next year. They'll generate significantly more surplus cash flow than expected, which they can use to further fortify their balance sheets and repurchase shares. Both oil giant's already expected to deliver double-digit annual cash flow growth through 2030 at much lower oil prices ($65-$70 a barrel), fueled by their cost-savings initiatives and investments in low-cost supplies. The prospect of higher oil prices for longer has made them even more compelling investment opportunities this year, especially given the modest rise in their share prices.

Now's not the time to trim

The demand destruction caused by surging oil prices isn't nearly enough to offset the current massive supply shortfall. It will take months to repair the damage, which should keep crude prices high into next year. That suggests you should consider adding to your energy stock positions rather than trimming them, with Exxon and Chevron as great options.

JPMorgan Chase is an advertising partner of Motley Fool Money. Matt DiLallo has positions in Chevron and JPMorgan Chase. The Motley Fool has positions in and recommends Chevron, Goldman Sachs Group, and JPMorgan Chase. The Motley Fool has a disclosure policy.