Amid ongoing tensions in the Middle East and a shift by investors away from overvalued tech stocks, the U.S. energy sector is outperforming the broader market by a record margin. Data shows that the S&P 500 Energy Index has gained 39% so far in the first quarter of this year, while the S&P 500 has declined 7% over the same period. The sector has risen for 14 consecutive weeks, surpassing the previous record of nine weeks set in 2007. On an individual stock basis, energy giants such as ExxonMobil (XOM) and ConocoPhillips (COP) are on track for their best quarterly performance ever, with gains exceeding 40% in the first three months.
Since the political shift in Venezuela and the escalation of geopolitical tensions in the Middle East late last February, disruptions to shipping in the Strait of Hormuz and attacks on energy facilities have fueled supply concerns, consistently boosting energy stocks and crude oil prices. Brent crude has surged 85% this year. The rally in energy stocks has also been supported by a rotation of capital. Menno Hulshof, Head of Research at TD Securities, noted that as investors reassess the potential impact of artificial intelligence on certain companies, funds have flowed out of related sectors and into asset-heavy, low-obsolescence industries, including energy, driving a rapid rise in energy sector valuations.
This energy sector rally is not limited to the U.S. market; Canada’s equivalent index is also on track for its best quarterly performance on record. Looking back to the first quarter of 2022, the Russia-Ukraine conflict also drove a sharp increase in energy stocks, but that momentum proved unsustainable. Industry observers believe the current market dynamics differ. Hulshof pointed out that the market has shifted from earlier expectations of a rapid transition away from oil and gas to a renewed focus on the long-term value of traditional energy.
Rob Thummel of Tortoise Capital noted that compared to 2022, energy companies now show improvements in capital discipline and free cash flow yields, with stronger fundamentals. Even if oil prices retreat in the future, analysts expect companies like Chevron (CVX), ExxonMobil, and ConocoPhillips could still benefit from oil prices above $67 per barrel. With both WTI and Brent crude currently holding above $100 per barrel, even a 30% price correction would still leave room for substantial corporate profits. Additionally, rising natural gas demand driven by the energy needs of AI data centers is providing a further tailwind for related companies.
Matt Portillo, Partner at TPH&Co., the energy business of Perella Weinberg, analyzed that rising oil prices will drive near-term cash flow growth for producers and refiners, which companies may use to reduce debt or return capital to shareholders. Over the long term, as strategic petroleum reserves have been significantly depleted during the war, the subsequent restocking needs of various countries will provide fundamental support for energy stocks. Meanwhile, a projected decline in U.S. shale oil production over the next decade is also expected to provide long-term support for energy prices.
Portillo concluded that from a long-term perspective, energy stock valuations remain attractive. Although the sector has accumulated significant short-term gains, a pullback due to a potential easing of geopolitical tensions would represent a healthy market correction.
