[Editor's note: A version of this story appears in the January 2019 edition of Oil and Gas Investor. Subscribe to the magazine here.]

As of late November, crude prices had slid for seven consecutive weeks, and energy stocks had once again been taken to the woodshed. A key factor in the slide was the dramatic reversal in sentiment triggered in part by the unexpectedly generous waivers granted to purchasers of Iranian oil. But a reality of today’s markets is that computer-driven models likely also exacerbated crude’s slide.

In a Nov. 26 report, Goldman Sachs observed that the recent oil supply-demand outlook “simply doesn’t explain the magnitude of the sell-off,” even acknowledging recent pressure on Saudi Arabia to raise output and the U.S.’ action to grant waivers for Iranian oil. The answer, according to Goldman, was “the lack of discretionary risk capital devoted to commodity markets.”

This lack of discretionary risk capital has increased volatility as “systematic traders,” relying on computer-driven programs, have grown to exert “an outsized influence on commodity prices,” Goldman reported. “The key is that these systematic traders are based on rules that respond to price patterns or perceived risk premiums, which become more important than spot fundamentals ….”

The scarcity of discretionary money able to take the other side of a trade—given that “algorithmic system trading” is said to comprise about 80% of crude oil trading—can make commodities appear to price in “a more dire demand outlook,” the report said. In turn, pricing can be “pushed below cost support”—below $55 per barrel (bbl) for WTI, an “unthinkable” level one month earlier.

With recent market conditions termed “unsustainable,” Goldman recommended taking a long position in Brent. “Inventories are not elevated, demand growth is likely to beat low expectations, Iran exports will decline further and, ultimately, core OPEC will reduce output, in our view.”

If crude prices are at risk of overshooting to the downside, energy equities have similarly followed a downward path.

“The oil-price correction has become a rout of historic proportions,” said Jason Gammel, Jefferies Group LLC equity analyst covering the integrated-oil sector. “Energy equities have been decimated in the oil sell-off.”

Gammel compared the severity of the crude-price collapse to that “in the aftermath of the November 2015 OPEC meeting, when the group decided not to act in the face of a very oversupplied market.” The primary difference, he said, was “the lack of an obvious catalyst, although the Saudi decision to surge production has dramatically increased the market oversupply in a very short period.”

Gammel said the integrated-oil stocks he covers were, on average, already pricing in a Brent price of $48/bbl. This compares with a January futures contract for Brent price of over $60/bbl for the same date, while the like WTI futures contract settled at just over $51.50/bbl.

Relative to prior corrections, the sector was in a much better position to weather the price downturn, Gammel added. The average breakeven price for stocks under coverage, where cash flow from operations covered capex plus dividends, was a Brent price of $51/bbl compared with $110/bbl in 2014.

But can a declining base of energy investors stung by recent losses step up again after recent drops in commodity and equity prices? How about the generalist investors?

“Capital discipline is still very much in evidence, and cash returns to investors have been prioritized. This is the performance that we would have expected to attract the generalist investor. Unfortunately, the oil price did not cooperate,” Gammel said.

“We do not expect that the generalist investors will put money to work in the sector while oil prices are falling, but valuations are compelling and risk/reward is currently skewed to the upside with the stocks discounting $48 Brent.”

Prior to OPEC’s critical meetings on Dec. 6 and Dec. 7, Gammel warned that “a production cut of over 1 million barrels per day (bbl/d) with Russian cooperation seems the minimum response necessary for Brent to catch a bid. Anything less could be ugly from a price standpoint until the market rebalances.”

(After the intra-OPEC meeting and a subsequent meeting that included Russia, the OPEC+ group agreed to a total cut of 1.2 million bbl/d among them.)

RELATED: Analysts: OPEC Decision Good For Global Market, US Shale Producers

Unfortunately, this was not before unsettled sentiment had taken its toll. In prior-day trading, crude prices crumbled and E&P stocks tumbled, with several stocks making 52-week lows—e.g. Apache Corp. (NYSE: APA), Concho Resources Inc. (NYSE: CXO), Cimarex Energy Co. (NYSE: XEC), Parsley Energy Inc. (NYSE: PE) and Pioneer Natural Resources Co. (NYSE: PXD), to name just a few.

Indeed, an ugly outcome.

Chris Sheehan can be reached at csheehan@hartenergy.com.

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