Will oil give another jolt to the energy sector?

E*TRADE Securities2


Last week, President Trump followed through on his campaign promise to pull the US out of the Iran nuclear deal. The anticipated announcement drew so much attention that when the first few reports that surfaced before the press conference incorrectly predicted the US would stay in the deal, a flurry of selling in WTI Crude incited a drop to almost $67 a barrel.1

Just goes to show how oil can move.  And while the Iran machinations are just one of several factors at play, the above deserves some consideration as investors begin to eye the energy market amid rising oil prices. Because while higher prices at the pump likely won’t make any consumer’s day, investors may be able to find opportunities within this sector.

First for some context: global growth and supply dynamics have likely contributed to the rise in crude oil prices. Crude oil bottomed out below $30 a barrel in early 2016, and since last summer has been on a tear, rising roughly 50% amid relatively strong economic fundamentals at home and abroad. In recent days oil has settled at around $70 a barrel, periodically stretching to $71.2  

So what about Iran?  

Analysts point to the fact that several other countries are sticking to the agreement. Russia, France, Germany, and the UK still support the agreement, and they’ve even noted they’re interested in opening a new round of negotiations.3 However, this is subject to change as discontent grows in Iran. Additionally, Iran’s ability to export oil may come under pressure as transacting with the country becomes more precarious politically.

What about producers?   

Unsurprisingly, higher barrel prices benefit producing countries such as Russia, Brazil, Nigeria, and the US, while it puts the squeeze on countries reliant on importing, such as India. We also recently noted that the rise in crude prices could create tailwinds among alternative fuel companies, most notably solar, as key stocks in this corner of the energy sector have recently seen positive gains. 

On the year, energy stocks have been one of the better performers compared to the broader market.5 Oil and gas producers depend on cost-efficient production due to the fluctuations of the oil market, and the higher crude prices rise, the greater the margins can be for these companies. Energy companies saw strong first-quarter profits, leading to a number of stock buyback announcements, which can further benefit shareholders.6  

In the fixed income markets, high-yield bonds could benefit as a large segment of the sector is tied to borrowers that are more profitable amid rising oil costs.7

On a macro level... 

Market observers are now likely questioning whether the higher oil prices will stoke inflation, and in return, dampen global growth. This could put central bankers in a tough spot: They can raise rates to counter inflation, but by doing so risk creating a one-two punch of higher borrowing costs combined with higher energy prices, creating headwinds for the economy.

The takeaway

Bottom line: Investors should keep a clear head as they consider the oil and gas market. Commodities are notoriously volatile, so oil prices can drop just as quickly as they rise, as can the equities of energy companies. The next big move could come from OPEC deciding to remove caps on production limits, or a renegotiated deal with Iran. And so while oil prices today can present some interesting opportunities, investors should be mindful of their exposure within the context of an overall diversified portfolio, mapped against their risk tolerance, time horizon, and goals.

1. Liptak, Kevin. “Trump withdraws from Iran nuclear deal, isolating him further from world,” CNN Politics, 9 May 2018, https://www.cnn.com/2018/05/08/politics/donald-trump-iran-deal-announcement-decision/index.html

2. Roy, Sumit. “Energy ETFs heat up as oil tops $70,” CNBC, 12 May 2018, https://www.cnbc.com/2018/05/11/energy-etfs-heat-up-as-oil-tops-70.html

3. Summers, Jessica. “Crude Holds Above $71 With Global Turmoil Seen at Bay for now,” Bloomberg, 9 May 2018, https://www.bloomberg.com/news/articles/2018-05-10/oil-extends-gains-as-u-s-inventories-dip-trump-exits-iran-deal

4. “Oil 2018,” International Energy Agency, 5 March 2018, https://www.iea.org/oil2018/

5. Meyersohn, Nathaniel. “Wall Street is back on the oil bandwagon,” CNN Money, 9 May 2018, http://money.cnn.com/2018/05/09/news/companies/oil-prices-iran-stocks/index.html?iid=EL

6. Narayanan, Aparna. “Top Shale Oil Names See Profits Soar As Crude Passes &70,” Investor’s Business Daily, 10 May 2018. https://www.investors.com/research/industry-snapshot/shale-oil-crude-oil-price/

7. Sekera, Dave. “Rising Oil Prices Support Modest Rally in Corporate Bond Market,” Morningstar, 14 May 2018, http://www.morningstar.com/articles/865617/rising-oil-prices-support-modest-rally-in-corporat.html