Oil surges on Iran conflict

Oil prices had already climbed nearly 20% this year before the onset of the US and Israel’s military campaign against Iran on February 28. With oil prices accelerating in the aftermath of the conflict with Iran, here’s what investors might expect for their impact on markets.

Oil prices surge after strikes on Iran

On Monday, West Texas Intermediate crude oil jumped above $71 a barrel and Brent Crude climbed above $77 a barrel—the highest levels in nearly 9 months. Most US stocks fell at the open on Monday before recovering intraday. Notably, energy stocks rallied while transportation stocks fell.

How this conflict affects markets will depend on how long it lasts and to what extent it disrupts global trade. With that said, given Iran’s position in global oil markets, a protracted military campaign against Iran could result in a greater impact on energy prices than the conflict with Venezuela earlier this year. While Venezuela accounts for less than 1% of global oil production, Iran’s production is pegged at about 3% of global oil output.

Moreover, the Strait of Hormuz—which lies between Iran and Oman and is de facto controlled by Iran—is a major chokepoint for seabound oil and liquefied natural gas. Roughly 20 million barrels per day travel through it, representing around 20% of the world’s oil supply, according to data from the US Energy Information Administration. Plus, leading marine insurers canceling war risk coverage and/or raising rates has had the effect of halting traffic in the strait and broadly increasing oil shipping rates.

The potential impact of higher oil prices on the global economy and markets cannot be understated. Energy is a ubiquitous cost for businesses to varying degrees. Consider the airlines industry, for example, where jet fuel typically accounts for 20% to 30% of all operating costs. Unsurprisingly, airline stocks fell sharply on Monday.

What might the broad market impact be due to rising energy costs? Jake Weinstein, senior vice president in Fidelity’s Asset Allocation Research Team, thinks that there could be reverberations in consumer spending and consumer confidence if oil prices continue to rise, but it’s still too early to tell what the full effect will be.

“Businesses may have to pay more for higher energy costs along with consumers,” Weinstein notes. “With that said, I don’t see enough of an impact on economic growth yet that would swing the US out of its current stage of the business cycle and into a recession. I do think we could see more volatility in oil markets and interest rates in this new era of geopolitical risk.”

What’s next for energy prices?

Kristen Dougherty, manager of the Fidelity^® Select Energy Portfolio (), thinks the energy market had already incorporated some geopolitical risk into commodity prices in recent months. “I do expect some temporary constraints on global oil supply, and for oil prices to continue to drift higher until either the conflict resolves or producers in other parts of the world have time to respond to price signals and raise production,” Dougherty says. “In the longer term, the global oil market remains deep and liquid, and I don't expect a significant dislocation from recent events.”

Dougherty is navigating the latest developments in the Middle East by being selective among energy stocks, which was the best-performing sector on Monday. “My fund is focused on finding energy companies with reasons for outperformance, which can become mispriced in fluid environments such as these.”

Given the evolving conflict, investors might consider several possible outcomes for oil prices over the near term with varying effects:

• Oil prices rise but remain relatively contained. If the conflict de-escalates, further oil price increases could be limited as longer-term forces keeping prices relatively low prevail. Among them: growing shale supply and technology developments that have decreased the cost of exploration and production. Here, investors might expect a minimal impact on the broader economy.
  
• Oil prices continue to seep higher. As long as oil markets are disrupted, oil prices could continue to rise until demand destruction eventually counterbalances price increases. In this scenario, investors might expect an increasingly negative impact on most companies due to higher costs. Industries that have relatively greater exposure to energy costs would likely be affected the most (e.g., airlines, shipping, trucking, chemical manufacturing, and agriculture).
  
• Oil prices spike to multi-year highs. Fidelity’s Capital Markets Strategy group notes that, if maritime traffic through the strait pauses or slows for longer than anticipated, oil could immediately surge past $100 to $120 per barrel, with "tail-risk" scenarios pushing prices toward $200 per barrel. It is hard to assess what the full impact of an extreme price shock would be without knowing how long very high oil prices persist, but any such scenario would be decidedly negative for global markets.

What should investors do now?

Investors should continue to monitor oil prices and their potential impact on markets. If energy market disruptions persist for longer than expected, investors may want to evaluate their portfolios and consider some rebalancing.

But as recent market action reveals, investors should avoid making significant adjustments to their portfolio during instances of geopolitical unrest. Once the initial market response dissipates, markets tend to adjust back to their long-term trends. And adverse market events are a reminder that maintaining diversification remains critical.