Before the geopolitical conflict in the Middle East broke out, Brent crude was trading in the $60 range. As fighting flared, news from the conflict pushed oil up to just over $130 a barrel. Today, as the two sides appear to have reached a tentative agreement to end the conflict, oil is trading around $80.
It seems logical to expect oil to return to $60 in short order, assuming the agreement to end the conflict holds. But two of the world's largest energy companies, ExxonMobil (XOM +0.17%) and Chevron (CVX +1.05%), have warned that industry fundamentals are weaker than Wall Street realizes. That could mean higher, not lower, prices once fundamentals start to drive energy prices.
Image source: Getty Images.
What's going on with oil?
The geopolitical conflict in the Middle East effectively shut the Strait of Hormuz. It is estimated that about 20% of the world's oil flows through that chokepoint. That's a huge amount of oil, and it is why the Strait became such an important point of contention. You can't simply shut off the spigot and expect nothing to happen.
The obvious first impact was a rapid rise in energy prices. However, that was just the most obvious impact, and the one that got the most media attention. In the background, companies and countries had to deal with less oil. However, the energy industry is accustomed to dealing with minor disruptions, such as shipping delays, which can disrupt the normal flow of oil and natural gas. This is why companies and countries have energy reserves. Those reserves were tapped during the conflict to soften the impact of the reduced energy supply.
NYSE: CVX
Key Data Points
Exxon and Chevron have both warned that inventories are at worrying levels. To put a number on that, the U.S. strategic petroleum reserve fell to roughly 340 million barrels in mid-June, the lowest level in 40 years.
To be fair, the drop in the reserve started in 2011, well before the current conflict. However, starting in mid-2023, the reserve began to be rebuilt. All the gains have now been lost, and the U.S. has to start over. But the United States isn't alone in this process; countries and companies around the world have tapped their reserves as well.
Higher oil prices could emerge even as supply opens up
The energy sector doesn't work like a switch; you can't just turn it on and off at will. There is a process involved in producing, transporting, and processing oil and natural gas. As newsflow around the conflict recedes, the fundamentals of the energy market will likely take center stage. Exxon and Chevron are both openly warning that the fundamentals aren't very good right now.
NYSE: XOM
Key Data Points
In the long run, industry watchers like the International Energy Agency (IEA) expect a glut of oil to lead to lower energy prices. But that isn't expected to occur until some time in 2027, with the IEA warning that it could take months for the energy market to stabilize, assuming the agreement to end hostilities holds.
According to the IEA, global reserves could hit historic lows before oil becomes more available toward the end of 2026. That means there could be months of uncertainty ahead for the energy sector, and it wouldn't be at all shocking to see oil prices rise in the span. The energy sector has a long history of being volatile.
This is why sticking to the giants is a good choice
While the current upheaval in the energy sector has been headline news, it's not surprising from a historical perspective. In fact, it is par for the course. Which is why most investors looking to include an energy component in their portfolios should probably stick with financially strong and diversified industry giants like Exxon and Chevron.
They have proven that they can handle the ebbs and flows of the energy sector in relative stride. Notably, they have both increased their dividends annually for decades, demonstrating their resilience. Of the two, Chevron is smaller but has the higher yield, at around 4%, which should make it particularly interesting to income-focused investors. That said, Exxon is usually one of the most efficient operators in the industry, so if you like sticking to the biggest and best, it will probably be the better pick for you.
