The third quarter of 2023 was a tough one for Wall Street. In particular, the S&P 500 — which tracks the biggest U.S.-listed companies — closed down around 4% in what was brought about by a severe setback consecutively in August and September.

Market participants expressed significant worry as the Fed warned of an additional 25 basis point rate hike before the year-end, indicating a prolonged period of higher interest rates to fight the stubborn inflation. Consequently, the major U.S. equity indices were caught up in a selloff even as the war between Russia and Ukraine continues to drag on.

But through the stock market’s first quarterly loss of 2023, the Oil/Energy sector stood out, with oil prices within spitting distance of the $100-a-barrel threshold and some of the companies being the biggest winners of the July-September period. The standout performers of the third quarter were Marathon Petroleum (MPC Quick QuoteMPC - Free Report) , Phillips 66 (PSX Quick QuotePSX - Free Report) , Halliburton (HAL Quick QuoteHAL - Free Report) , Valero Energy (VLO Quick QuoteVLO - Free Report) and APA Corporation (APA Quick QuoteAPA - Free Report) .

Energy Stands Tall Amid Broad-Based Decline

Although the S&P 500 finished the quarter in the red, a particular group of stocks stood out.

On the sectoral front, it was energy that topped the S&P standings for the period with an outsized gain, while most others lost value. The space has comprehensively outperformed the market, with the Energy Select Sector SPDR’s (an assortment of the largest U.S. energy companies, popularly known by its ticker, XLE) impressive gains, primarily fueled by a tight supply picture and the geopolitical premium. To be precise, the energy index generated a total return of 11.3% in the third quarter against the S&P 500’s decline of 3.7%.

Much of this can be attributed to Saudi Arabia's June declaration of a unilateral reduction in oil output by 1 million barrels per day. This production cut, initially extended through August and September and subsequently continued for the rest of 2023, has served as the primary driver of the increase in oil prices.

In addition to Riyadh's efforts, recent data from the Energy Information Administration revealed a significant decrease in U.S. commercial crude inventories. Since July, these inventories have fallen by almost 42 million barrels. To put that in context, total domestic stock now stands at 416.3 million barrels — 3.3% less than the year-ago figure and 4% less than the five-year average.

Furthermore, supplies at the Cushing terminal (the key delivery hub for U.S. crude futures traded on the New York Mercantile Exchange) have now dropped to 22 million barrels — the lowest since July 2022.

In response, WTI oil prices topped $95 last week for its highest intraday level since August of last year. While there are jitters over high inflation and stuttering economic growth, these have more than offset the tightening supply outlook.

Most energy investors have had something to cheer about in the September quarter, but some stocks certainly performed better than others. The five largest contributors to the quarterly sectoral gains were Marathon Petroleum, Phillips 66, Halliburton, Valero Energy and APA Corporation.

Will these winners maintain their run in the last quarter of 2023, too, or will they eventually run out of steam? Here's a summary of them:

Marathon Petroleum: The company is a leading independent refiner, transporter and marketer of petroleum products. MPC’s $23.3 billion acquisition of Andeavor has integrated the premier assets of both companies, bolstering the scale and leadership position of the combined entity in the United States. As it is, Marathon Petroleum's access to a lower cost of crude in the Permian, Bakken and Canada helps it to benefit from the differentials.

MPC handily outperformed all but one stock and was up 29.8% during the period, ranking second on the S&P 500 list. While Marathon continues to generate strong cash flows amid a disciplined capital strategy and increasing shareholder returns, this Zacks Rank #3 (Hold) downstream operator’s further price gains could be limited by operational issues and an unpredictable refining macro backdrop.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Phillips 66: Another major refiner in terms of size, efficiency and strength, Phillips 66 buys, sells and refines crude oil and other feedstocks at its refineries. PSX, with a throughput capacity of 2 million barrels per day, owns an interest in 12 refineries in the United States and Europe. Moreover, it owns 7,110 branded U.S. outlets and 1,700 international ones.

Phillips 66, carrying a Zacks Rank of 3, rallied 26% last quarter. With its vast pipeline network, the company is also a big player in the midstream business, generating stable fee-based revenues. Higher commodity prices have driven upstream investments, thereby increasing volumes for midstream operators. However, due to lower demand for refined petroleum products, the firm might miss the potential gain in refining margins. Thus, Phillips 66 is likely to witness a decrease in its total capacity utilizations. Hence, we expect pre-tax income from refining business to be lower this year.

Halliburton: It is one of the largest oilfield service providers in the world, offering a variety of equipment, maintenance, and engineering and construction services to the energy, industrial and government sectors. Halliburton operates in over 80 countries. Founded in 1919, Halliburton employs more than 40,000 people and operates under two main segments: Completion and Production, and Drilling and Evaluation.

This stock was the third-best sector performer on the S&P 500 Index, with shares appreciating 22.8% in the past quarter. But it will be a bumpy ride in the near-to-medium term. While the company’s significant global presence exposes it to worldwide geopolitical risks, the rapidly rising labor and material costs are cutting margins. Finally, the Zacks Rank #4 (Sell) energy company’s above-average debt-to-capitalization and low dividend yield are other negatives in the HAL story.

Valero Energy: Among all the independent refiners, Valero offers the most diversified refinery base with a capacity of 3.1 million barrels per day in its 15 refineries located throughout the United States, Canada and the Caribbean. The majority of VLO’s refining plants are located in the Gulf Coast area, from where there is easy access to export facilities.

This Zacks Rank #3 stock ended 20.8% higher in the last three-month period. The Gulf Coast presence helped it to expand export volumes over the past years and gain from high distillate margins. Valero is expected to capitalize on the rising demand for distillate fuel. However, there are concerns about Valero’s high debt levels, which leave it vulnerable to any volatility in commodity prices. Also, higher oil and gas prices can lead to increased input costs for Valero, thereby putting pressure on the profit margins. This suggests a tricky risk/reward profile and limited upside potential VLO.

APA Corporation: It is one of the world's leading independent energy firms engaged in the exploration, development and production of natural gas, crude oil and natural gas liquids. Geographically, the company’s operations are in the United States, Egypt and the North Sea of the United Kingdom. APA also holds acreage in offshore Suriname (South America) and other international locations.

This stock, with a Zacks Rank of 3, ended 20.3% higher in the July-September period. APA’s slew of discoveries in offshore Suriname, through its joint venture with TotalEnergies, is a major positive catalyst for the company. Over time, Suriname is expected to become one of APA’s major assets with significant cash flow potential. However, the company's high leverage restricts its financial flexibility. Moreover, APA’s significant exposure to forex currency and the associated risks might put off some investors.