- Benchmark indices shrug off conflict in Middle East, but oil sector is drifting sideways
- Fresh weakness in crude oil prices shows investors’ confidence that Israel-Iran conflict will be contained
- UK oil sector represents 8.8% of FTSE All-Share’s total stock market valuation (against a post-1995 average of 12.4%)
- Lack of interest in oil and gas producers Stateside is even more stark
- Valuations imply investors are more worried about oil fields becoming a stranded, and devalued, asset rather than commodity price strength due to war
“Financial markets can never be always right, but their views must always be respected and right now it looks as if they are spot on when it comes to the risks posed by geopolitical tensions in the Middle East,” says AJ Bell investment director Russ Mould.
“Oil prices gained little ground when tensions flared between Israel and Iran last week and they shed those gains and more once the ceasefire was announced. This suggests investors believe a wider conflict will not develop, and that crude prices are not likely to spike, with the result that oil companies’ shares remain in the doldrums.
“The war between Ukraine and Russia, a leading global producer of oil and gas, continues three years on from its start and even that is not stoking too many fears that hydrocarbon prices are primed to surge and replicate the spikes of the 1970s that did so much to fuel stagflation and lead to a rotten decade of investment returns for anyone who did not own an awful lot of gold.
Source: LSEG Refinitiv data
“There are clearly far more important, humanitarian issues at stake in both conflicts, but, from the narrow perspective of financial markets investors will continue to pay attention to their implications for oil and gas prices in particular, given the importance of cheap energy both for growth and keeping a lid on inflation for major Western economies. Stock and bond markets still hope, and yearn, for a return to the low-inflation, low-interest-rate days of the 2010s and early 2020s and a surge in energy prices could quickly disturb that rosy scenario.
“Near-term sentiment toward oil and gas prices remains broadly negative for three reasons.
- The International Energy Agency (IEA) continues to assert that demand growth remains anaemic. It argues demand will increase by barely 720,000 barrels per day, on average, in this year, a marked slowdown from the two-million-plus pace seen post-pandemic in 2022 and 2023. The IEA’s latest forecast also assumes demand growth of just 740,000 barrels a day in 2026, thanks to a weak economic growth outlook (where tariffs and trade remain a source of uncertainty) and the increased adoption of renewable energy technologies.
- The IEA also argues that supply is plentiful, even allowing for tensions in the Middle East and output disruptions in Libya, where the febrile political situation means supply remains well below its potential and past peaks. There are also suggestions that Saudi Arabia and UAE could increase output if needed, while global inventories are building, according to the IEA at the rate of one million barrels a day, to stand at 7.7 billion barrels at the last count. OPEC+ continues to restrain capacity, too, so there is scope for increased supply here. Meanwhile, American output continues to surge and stands near record highs of 13.4 million barrels a day, according to the US Energy Information Administration. This is largely thanks to shale and it means that OPEC+ is not the only game in town.
- Israel has promised not to target Iranian oil facilities in any attacks. The Kharg Island terminal there is particularly important, as it ships 1.6 million barrels of oil a day, or just under 1.5% of total global demand. If Iran were to suffer the loss of its production and refining capabilities, then it would have less to lose by trying to close the Straits of Hormuz, a shipping lane that carries up to a fifth of global oil shipments. If Iran can produce and pump then to cut off its ability to ship would be an act of economic self-harm, and one that seems unlikely when the theocratic regime has more than enough problems with which it already has to deal.
“Overlaying of all of this remains the long-term issue of the global transition toward more renewable sources of energy and away from hydrocarbons which should, in theory dampen demand for oil in particular.
“Investors are clearly taking all of this on board, as oil and gas stocks continue to drift sideways, at best. They are little or no higher now than they were in 2022, even if headline equity indices continue to progress toward, or beyond, past peaks.
Source: LSEG Refinitiv data
“This torpid performance means that oil and gas stocks continue to lose importance within the broader headline indices.
“Oil and gas producers represent just 8.8% of the total stock market value of the FTSE All-Share index here in the UK, compared to a post-1995 average of 12.4% and 2009’s peak of 22.3%. The low was 6.1% in autumn 2020, after oil’s Covid-19 inspired collapse.
Source: LSEG Refinitiv data
“Investor disinterest is even more marked in the technology-rich US equity market. Oil and gas stocks are down to 3.0% of the total value of the S&P 500 index, compared to a long run average of 7.7% and 2008’s peak of 16.2%. The low was 1.9% in late 2020.
Source: LSEG Refinitiv data
“Investors therefore seem more concerned that oil and gas fields will become stranded, wasting assets than they do about the risk of a conflict restricting or cutting off supply.
“Yet the lowly valuations attributed to oil and gas producers may catch the attention of brave, patient contrarians.
“Demand continues to grow. Even if the IEA and OPEC expect less growth than before, the globe continues to rely heavily on hydrocarbons. Moreover, the best cure for low prices is usually low prices, because it fuels demand and limits supply. Drilling activity in the USA, and indeed worldwide, remains subdued according to the Baker Hughes rig count, despite President Trump’s exhortations to the contrary.
“Trump may be keeping a wary eye on America’s Strategic Petroleum Reserve (SPR) which still stands way below its 714-million-barrel capacity, at 421 million barrels, after the Biden administration’s liquidation of assets to try and cap fuel and gasoline prices for US consumers. At some stage it would make sense to top this back up, especially at a time when energy supply could be a matter of national security. Total inventory of 823 million is the lowest mark since late 1986.
“It might therefore take too much for oil and gas prices to surprise on the upside, unlikely as that seems right now, if even a quickfire war in the Middle East fails to move them. After all, it is possible to buy eight major oil and gas producers for $2.9 trillion, a fraction less than Apple’s $3 trillion stock market capitalisation, even though the oils’ forecast aggregate after-tax profit this year is expected to be almost double that of the Californian technology company.
“Apple is clearly expected to show better growth over the long term, although its recent record hardly suggests as much, because 2025’s consensus analysts’ net profit forecast of $108 billion is not a huge improvement on 2021’s $95 billion (a figure the firm failed to reach in 2024).”
