Written by Jacob Friedland
Global oil prices have recently experienced significant volatility (1st chart), surging amid escalating geopolitical tensions in the Middle East. Although prices are lower than April highs, oil spiked ~18% in mid-September, largely driven by intensifying conflicts between Israel and Iran. Many investors are anticipating further conflict and thus are positioning for further gains in oil prices.
While geopolitical risks can fuel short-term rallies, several factors make us question the outright bullish sentiment. Global oil production has risen significantly since 2020, with the U.S. becoming a net oil exporter of 2.7 million barrels per day. Saudi Arabia has also warned OPEC members that it may use its excess capacity to drive prices down to $50 to regain market share. Finally, the biggest marginal buyer of oil – China – has seen its imports decline (2nd chart) despite increasing inventory availability from Russia. These macro demand drivers suggest current or even lower prices in the near-term if the Middle East conflict remains localized.
From an investment standpoint, oil and energy stocks have already benefited from the geopolitical uncertainty. Energy stock sector ETFs gained ~10% in September and a further 2% so far in October. However, we are starting to see signs of retracement as investors are not willing to continue paying a risk premium without evidence of expanded conflict. In our view, a lasting oil price bull market requires stronger demand, driven by U.S. or China economic growth above expectations, not just fears of a supply crunch. As such, we do not see a reason to overweight energy stocks today. The risk of geopolitical flare ups remains, however, and thus we maintain our neutral position in energy commodities as a hedge to broader portfolios.
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