The market's soothsaying machine was well-oiled this spring.

Shares of the energy supermajors, which rode the rally in crude to dizzying heights in 2004 and through the winter, suddenly began to fall in March. A month later, the price of oil also tanked.

Investors who got out near the top in stocks such as

Exxon Mobil

(XOM) - Get Report

and

Chevron

(CVX) - Get Report

booked double-digit gains that date to the beginning of 2004. Their success focused the market on a sector that previously wasn't known for its hot-money appeal.

For those who didn't sell or were left out altogether, oil is tempting them again. It has run about halfway back up the ladder it descended last month for a recent price of roughly $54 a barrel, $4 below its all-time high. This time, the interval of clairvoyance in the stock market has been shorter: the

iShares Dow Jones US Energy

(IYE) - Get Report

ETF began what has been a 10% retracement on May 16, about a week before oil rebounded.

But for investors thinking of jumping back into oil stocks, the downside risk looks greater. Even after their April pullback, shares of the big producers currently reflect optimistic assumptions about both the absolute price of oil and its sustainability. True, oil might run back to $60 a barrel. But it's also possible that the kind of supply problems that would send the commodity that high could hurt the companies that rely on it for growth.

"Profit growth among the energy sector is going to stagnate" says Ned Riley, former chief investment strategist at State Street Global Investors who now manages a private consulting firm. "We've had a good run, but the fever that came around the Goldman Sachs $100 a barrel drama is over."

Interestingly, Goldman's now famous "super spike" call, in which the bank opined that crude could top $100 a barrel in certain extreme scenarios, came just three days before oil peaked on April 4 at $58.28, just prior to a 20% selloff.

By then, the slide in equity prices was already halfway over.

Royal Dutch/Shell's

(RD)

shares, for example, fell from a high of $64.94 on March 4 to $60.06 on April 1 to $56.44 on May 13. Exxon, which peaked at $63.57 March 4, was at $60.55 on April 1 before landing at $53.35 on May 16. For Chevron, it was $62.08 on Feb. 28, $59.31 on April 1, and $51.51 on May 16.

The Amex Oil Index, which lists stocks of 13 oil supermajors, outperformed the

S&P

by a whopping 16 percentage points in the first quarter but has been flat during the second. The iShares US Energy ETF has fallen 6% since it peaked at $79.18 in early March, and the

S&P Global Energy Sector

dropped 7% from its peak on March 4.

Now that the uptrend has resumed, even some oil bulls are getting nervous.

"I am overweight on the energy sector but not happy about it," says Hugh Johnson, chief investment officer at Johnson Illington Advisors, which has more than $1.5 billion under management. "The S&P 500 energy sector rose 17% in the first quarter. That can't continue forever."

The fate of oil companies is linked to oil prices; there is no getting around that. As long as oil prices are high, the majors are going to remain very profitable. The problem, as noted above, is that the shares tend to get ahead of the commodity; they currently reflect a rather bullish view on oil. What happens if oil sinks?

"Share prices are overextended and too high and depend on oil being above $50," Johnson says. "It better stay there."

Paul Nolte, who manages $50 million at Hinsdale Associates, says it would be bad news for the majors if oil came down. The stocks currently reflect oil prices of $55 to $57 a barrel, Nolte estimates. "Oil stocks rely on high oil prices. It isn't sustainable," he says.

Nolte, using a comparison of oil and oil company shares over the past five years, extrapolates that share prices are behaving as if oil cost $57 a barrel. "You would be better off buying crude than stocks now," he says.

Nolte scaled back his portfolio from overweight energy to market weight in January.

Also of concern are signs of slowing demand growth in the first quarter.

The latest report from the International Energy Agency, a private oil markets watchdog, said oil consumption growth in the U.S., the largest oil consumer, was down to 1.2% in the first quarter of this year, from 1.7% in the same time a year ago. Demand growth in China, the second-largest oil consumer, fell to 4.5% from 19.3% in the same period.

U.S. oil consumption growth in 2004 was 4.4% while gross domestic product growth was 4.5%. "Normally oil consumption grows about a half of the GDP," Riley notes. "Last year was not normal."

On top of that, OPEC has been pumping and exporting about 30 million barrels a day, the highest levels in 25 years, and it promises to increase its capacity by 3 million a day by 2006.

To be sure, the bull case on oil stocks remains the dominant one on Wall Street. Many analysts continue to view demand and supply fundamentals as tight, supporting the idea that major producers still have more room to grow.

Carmine Rositano, energy equity analyst at PIRA Energy Group, says the major oil producers are in the best financial shape they've ever been. "Exxon has more cash than ever before; in fact it has more cash than debt. When you have $30 billion in your hands, you are in a very good position."

ConocoPhillips

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, the largest refiner of the major integrated oil companies, showed the most growth, he says, and benefited from its debt reduction and refining margins.

Rositano also said companies have taken a conservative approach to their financial planning, basing their investment decisions on oil prices in the mid-$30 range. "They have played the cycle very conservatively because they have been burned before on sharp corrections. By calculating economic feasibility on lower oil prices they are disciplining themselves."

But even the most optimistic of the bulls admit that for short-term investors, the sector carries a lot of risk. Says Rositano: "If you are in the market to reap profit, it's probably better to sell and look elsewhere."