Investment Strategy View: Energy Dominance

Expect the Unexpected

Geopolitical events are dominating headlines of late, and so it’s natural to worry about the potential impacts they may have on the economy and your investment portfolio. To state the obvious, these events can lead to disruptions in global supply chains, trade, and economic activity. They’re also unpredictable, which can make it tricky for investors to position for them. And when there are tensions, oil markets usually find themselves caught in the crossfire.

In response to the latest escalations between Israel and Iran, some investors have begun fearing the potential for oil supply disruptions in the Middle East. That has helped push West Texas Intermediate (WTI) crude oil prices, the U.S. oil benchmark, up to $71/bbl from around $68/bbl last week, over a 4% jump. While energy prices are reacting to the escalation, the reaction has been relatively muted compared to oil shocks in past decades. This is in part due to the United States’ increased production of oil that reduced reliance on oil imports.

Relative to two decades ago, net imports of crude oil into the U.S. are nearly 80% lower, while domestic production has more than doubled. Less reliance on foreign oil provides a buffer against price spikes caused by geopolitical events, but the U.S. wouldn’t be immune against a large enough shock.

Black Swans Play in Oil

The Russia-Ukraine conflict is an example of such a shock, a true black swan event (which are defined as rare, unpredictable events that have major consequences), as the invasion and ensuing sanctions led to significant disruptions in global oil supplies. In the immediate aftermath (after WTI oil had already risen from $70/bbl to $90/bbl in anticipation of a possible conflict), U.S. oil prices shot up nearly 40% to $130/bbl. And while they didn’t stay at that level, they remained elevated for several months after.

To mitigate the impact of the price shock, the U.S. government released a million barrels of oil a day from the Strategic Petroleum Reserve (SPR) to help ease supply constraints. That action was pretty novel, but it also can swing in the opposite direction. Over the last year, the government has actually been buying about 100k barrels of oil a day to refill the SPR, which has helped smooth volatility in oil prices. In fact, some market watchers have even joked that by selling oil when prices were high and buying now that they’re lower, the government put on one of the best trades in markets over the last two years.

Potential Energy

It’s reasonable to expect that stocks would struggle if there does end up being a bigger oil shock. Even so, it’s worth remembering that geopolitical events are unpredictable and tensions don’t spontaneously dissipate. That means uncertainty will likely be elevated for an extended period of time. And as investors, we cannot entirely avoid the risks of external shocks.

Instead, investors can guard their portfolios by identifying parts of the market that are likely to outperform on a relative basis. Of course, the Energy sector is an obvious candidate to do well when oil prices spike, given higher oil prices directly translate to higher profits for energy companies. Look no further than in 2022 when Energy’s total return of +65% far outpaced the broader S&P 500’s total return of -18% while average annual oil prices rose 39%. But what else outperforms?

The above chart suggests that beyond Energy, the classic defensive sectors such as Utilities, Real Estate, Health Care, and Consumer Staples could also outperform if the economy were to experience a surge in oil prices. Conversely, economically sensitive sectors might struggle, as higher oil prices can push consumers to spend less on discretionary items and focus on essentials. For what it’s worth, defensives have already been serving as market leadership for nearly half a year now.

The world of markets can be complicated, with geopolitical risk being just one of many different types of uncertainties that haunt us. Risks don’t always come to pass, which can breed complacency in investors. But by being aware of underlying portfolio drivers and investing in an informed way, investors can improve their chances of achieving long-term success.

Communication of SoFi Wealth LLC an SEC Registered Investment Adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at www.adviserinfo.sec.gov. Mario Ismailanji is a Registered Representative of SoFi Securities and Investment Advisor Representative of SoFi Wealth. His ADV 2B is available at www.sofi.com/legal/adv.

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