Oil has fallen sharply. The next step will be crucial.

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Oil prices have fallen significantly and are now at a technical crossroads. Crude Oil’s next move will be crucial for investors in both oil contracts and oil stocks.

WTI Crude Oil

has fallen 9% to around $72 a barrel from its level just before the banking sector troubles surfaced earlier in the month. Those problems have stoked fears that lending and thus spending will slow, which would reduce demand for oil.

Oil is down 41% since peaking well over $100 in 2022. Initially, the war between Russia and Ukraine pushed the price higher, but since then, aggressive central bank rate hikes have dampened demand.

Now the price of oil is at a key level. If it breaks below the low $70 area, it might open the door for more losses. If it can scale above this area, it could mean that the commodity could be stuck in a larger uptrend from its early 2020 low.

A move above the low-$70 range would be “a first sign that the bottom is in,” John Kolovos, chief technical strategist at Macro Risk Advisors, wrote in a note last week.

The low $70 range is indeed an important technical point. Prior to this year, WTI crude has not been at this level since late 2021. Back then, the price had stabilized in the $70-$75 range until Russia’s invasion of the Ukraine issue pushed it higher in February 2022. Continued downside means oil could dip below the $65 area, the closest range buyers have entered in recent years. Another break below this range would leave the next key support level around $40.

For oil stocks – as measured by an energy exchange traded fund – to break a key support level, oil would need to see more than a minor decline.

Stocks are already trading stronger than one might think. The

Energy Select Sector SPDR ETF

(Ticker: XLE) is down just 9% to around $79 this month from its level just before the bank panic, right in line with the drop in oil prices. In theory, oil stocks should fall faster than oil prices. That’s because producers have a lot of fixed costs. If their sales fall as oil prices fall, profits fall even faster.

But oil stocks aren’t falling faster than commodities because they’re already cheap. According to FactSet, the ETF is trading at about nine times earnings estimates per share, well below the mid-teens multiple seen several times over the past decade. Because of this, the ETF’s price could hold the line in the low-$70s or high-$60s, where buyers have tended to come in over the past few years.

Investors still have some vested interest in buying oil stocks as companies continue to return large sums to shareholders in the form of dividends and buybacks.

Expected dividend and buyback in dollars from

S&P500

According to 22V Research, energy companies account for around 10% of the sector’s total market cap for the next year. That total cash return yield is far better than the sub-4% yield for 10-year Treasury bills. As a result, oil companies would likely still be returning a significant amount of cash to shareholders relative to their stock prices, even if the price of oil softened slightly, eating into energy companies’ earnings. However, crude oil needs to remain above the $65 area for cash yields to remain strong.

Energy investors should keep an eye on crude oil prices. If oil falls below its next support level, oil stocks would likely do the same.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com