Energy stocks began the third quarter on an upbeat note, as the sector was one of the best performers for July. Within the oil and gas complex, earnings results from the oil services, drillers and integrateds dominated headlines and influenced trading patterns.

The oilfield services (S&P 500 Oilfield Services, +13.5%), E&Ps (S&P 500 E&Ps, +7.2%) and integrateds (S&P 500 Integrateds, +7.1%) fared best, while drillers (S&P 500 Drillers, +5.4%) and refiners (S&P 500 Refiners, -1.7%) had mixed performances. Halliburton Co. rose more than 20% during the month after reporting second-quarter results that beat analysts' estimates and set a tone of optimism about strength in the pricing for North American land activity.

On the other hand, deepwater drillers provided cautious comments about activity, citing declining dayrates amid uncertainty about the Gulf of Mexico moratorium. However, comments from shallow-water drillers suggested a bifurcation whereby companies are experiencing increased utilization rates and pricing power for their high spec and newbuild rigs, while their legacy jackup and floater markets are under pressure.

The results from the integrated oil majors and refiners also provided a mixed, albeit much improved, picture of downstream operations. Majors Exxon Mobil Corp. (+4.6%), Chevron Corp. (+12.3%), ConocoPhillips (+12.5%), Royal Dutch Shell Plc (+10.4%), and Total SA (+13.4%) all posted better-than-expected results, which were largely attributed to their refining and chemicals margins.

In August, volumes declined and investors rotated out of risky assets with trading driven largely by economic data, after Fed chairman Ben Bernanke said the recovery had softened.

The beginning of August marked the height of earnings season for E&Ps. Better-than-expected results from producers, including Devon Energy Corp. (-3.4%), Anadarko Petroleum Corp. (+24.1%) and Chesapeake Energy Corp. (-1.7%) supported that subsector. However, the trend of outspending cash flow, notably among the small to mid-cap gas producers, weighed on sentiment.

Integrateds outperformed the other subsectors, despite posting a modest loss, as investors took advantage of their defensive nature. BP, however, plunged 9.94% as the company's final plugging of the blown-out Macondo well was delayed until September.

Energy stocks reversed August's losses and soared during September, mirroring gains in the broader U.S. equity market, which experienced its best September performance in 71 years. The U.S. dollar deteriorated, which supported both equities and oil prices, enabling the front-month WTI contract to post its biggest monthly gain in 1.5 years and the best quarterly performance since the fourth quarter of 2009. Within oil and gas, the oilfield services and drillers experienced the steepest gains (S&P Oilfield Services, +15.7%, S&P Drillers, +14.6%) as they recovered from recent underperformances, while the integrateds lagged (S&P Integrated, +7.0%).

Oil services and drillers, especially those operating in the Gulf of Mexico, attracted value buying during September on the depression in the share prices following uncertainty on new regulations in the aftermath of the BP spill.

National Oilwell Varco Inc. (+18.2%) and Cameron International Corp. (+16.8%) were beneficiaries of new orders and retrofitting while investors expressed concerns for offshore drillers with older fleets and for shallow-water drillers facing permitting delays, such as Noble Corp. (+8.6%). Late in the month, Petróleo Brasileiro S.A. (+8.8%) raised $70 billion in the world's largest share offering to finance the 5-billion-barrel-of-oil-equivalent purchase from the Brazilian government.

Natural gas inventories rose continuously during injection season, but the front-month commodity rallied 6.7% during July, supported by raised demand for gas-fired electrical generation. Crude futures briefly broke above the $80 level early in August before falling on investor fears as macro data continued to emphasize the likelihood of a "double dip" recession. Natural gas futures plunged 22.49% in August, the largest drop since July 2008, as bearish weather forecasts pulled prices lower and on a lack of threatening storms as well as high rig counts and production levels.

Energy is one of the few sectors that did not meaningfully participate in the broader equity recovery through Q3. While market leaders in other sectors advanced, and began to stall at quarter-end, energy appears technically well positioned to outperform through Q4. E&P stocks have rallied over 10% in September and are now trading at the top of their fair value range relative to long-term oil and gas price expectations and recent trading relationships.

According to Thomson Reuters' analysis, capital flow data indicates institutional investors were net buyers of the sector over the quarter. The institutional community (traditional and long-onlys) dominated trading, accounting for roughly 72% of all buying transactions during the quarter, and 57% of all sales.

Meanwhile, Hedge/Fast Money/Prop Desk investors were net sellers, as was the retail investment community. The largest capital inflows were primarily attributable to firms that secured more money market capital and taxable bond capital, indicating investors shied away from equity investments during the quarter. Investors withdrew a staggering $33.12 billion from domestic stock market mutual funds in the first seven months of the year.