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Iraq Crisis Fuels Short-Term Boom for Energy Stocks

Jul 01, 2014

Despite the incendiary conflict in Iraq that last week sent the benchmark price of Brent crude oil to more than $115 a barrel, U.S. stock markets largely shrugged off the oil threat.

In fact, a new energy crisis in the Middle East presents something of an opportunity for investors — albeit a fragile, short-term one.

While energy production has become much more geographically diverse, lessening the severity of a Mideast production shortfall, Iraq is still OPEC's second-largest producer. And as is the case during any threat to global oil production, the share prices of oil companies and the funds that invest in them soar on bad news, which is what happened last week.

Owing to greater demand for oil and geopolitical tensions, ExxonMobil , the largest energy company by market valuation, climbed 10.5% over the three months through June 20, compared to a 5.3% gain in the S&P 500 Index . BP was up nearly 15% over the three months ended June 20.

The last three months are important because they include a spate of good reports on economic growth in Europe and the U.S. and a run-up to the political strife in the Middle East. These events, and growing demand from developing countries such as China and India, have pressured oil prices upward.

The Vanguard Energy ETF , which holds a broad portfolio of oil and gas exploration, refining and pipeline companies, gained 16% in the quarter through June 20. It holds companies like ExxonMobil, Chevron and Schlumberger , and nearly all its holdings are based in North America. It's up about 16% in the three months through June 20.

For a fund that's not dominated by the most popular energy stocks, consider the Guggenheim S&P 500 Equal Weight Energy ETF , which holds a global portfolio of energy producers in roughly equal proportions.

The Guggenheim portfolio places more emphasis on smaller, lesser-known companies like Newfield Exploration Co. , Anadarko Petroleum and Nabors Industries . The fund is up nearly 16% for the three months through June 20. Independent companies like these may have more drilling activities in the areas where shale oil and gas are being discovered throughout North America.

Energy Shock Boomerang

Over a short period of time, it makes sense to hold energy stocks as a defense against rising oil prices. After all, companies make profits on price surges.

But on the consumer level, higher petroleum prices can act as a damaging boomerang.

When prices soar beyond a certain level, it brakes economic activity across the board. Higher fuel prices force people to drive less and stay away from stores, raise prices for everything from farm goods to plastics, and act as a tax on economic growth.

During the last draconian oil-price run-up in 2008 — when crude oil prices topped $140 a barrel — the combination of an energy shock, a banking meltdown and massive unemployment from Athens to San Francisco created a recession in Europe and North America. Towards the end of that year, energy prices bludgeoned an already-hobbled economic situation and the Vanguard Energy fund lost nearly 40% of its value, slightly more than the S&P 500 Index.

Looking ahead, what may mitigate any traumas in terms of oil prices will be growing U.S. oil and gas production, particularly in regions where "fracking" technology has liberated more hydrocarbons from shale formations from the Appalachians to North Dakota.

Production in the U.S. was up a record 1.1 million barrels per day last year, offsetting declines in global output from Libya, Nigeria and Iraq — all due to political strife.

"The huge investments seen in the U.S. have been encouraged and enabled by a favorable policy regime," BP economist Christof Ruhl told Reuters. "And this has resulted in the U.S. delivering the world's largest increase in oil production last year. Indeed, the U.S. increase ... was one of the biggest annual oil production increases the world has ever seen."

Across the globe, the future for energy stocks is positive long term. Consumers in China, India and Africa are buying petroleum-hungry vehicles. And until less-costly alternatives present themselves, fossil fuels will power the engines of these developing economies.

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