Energy stocks are regaining investor favor as ongoing Middle East conflicts and fading prospects for a quick US-Iran ceasefire keep international oil prices elevated. The S&P 500 energy sector index climbed as much as 1.8% during Tuesday's trading session, approaching the all-time high set earlier this year. Should Tuesday's gains hold through the close, the index would mark its first record closing high since March 27.
Earlier this year, Middle East warfare and supply risks at the Strait of Hormuz drove a significant rally in energy shares. However, as Washington and Tehran briefly engaged in negotiations, market concerns over geopolitical tensions subsided, pulling the sector down as much as 16% from its peak. Since early July, though, energy stocks have regained momentum amid the prolonged absence of a ceasefire. To date, the sector has rebounded roughly 20% from its July 1 cyclical low, once again approaching its prior highs.
Rob Thummel, senior portfolio manager at Tortoise Capital, noted that many investors who missed the initial energy rally are now determined not to sit out the second wave. At the same time, global geopolitical risks remain elevated, and even if oil prices eventually retreat, energy stocks are becoming increasingly vital within investment portfolios.
Year to date, Brent crude futures have climbed about 50% due to supply constraints stemming from the Middle East conflict. High oil prices have not only lifted energy valuations but have also markedly improved earnings and cash flow at major US oil companies. Chevron Corp (NYSE: CVX) posted a year-over-year earnings-per-share surge of more than 240% in the second quarter, while Exxon Mobil Corp (NYSE: XOM) saw profits jump 115% over the same period. Additionally, Chevron is projected to generate roughly $12.5 billion in extra free cash flow by 2026.
Thummel pointed out that the cash flow improvements at these firms are not solely attributable to higher oil prices; operational efficiency gains and share buyback programs have also played a significant role. The benefits of tight energy supplies extend beyond oil producers, as refiners are also capitalizing on constrained refined product markets. Valero Energy Corp (NYSE: VLO) reported its best-ever quarterly earnings per share in July, while PBF Energy Inc (NYSE: PBF) and HF Sinclair Corp (NYSE: DINO) also delivered their strongest profit performances in years.
James West, analyst at Melius Research, believes that with corporate earnings continuing to grow and supply tightness for refined products like diesel and jet fuel potentially persisting for several years, current energy valuations remain attractive. The market is gradually pricing in expectations that oil and refined product prices may stay elevated for an extended period, leaving room for further upside in energy shares.
That said, should the US and Iran eventually reach a ceasefire and push oil prices lower, earnings growth at energy firms could slow. Yet analysts argue that even a truce might not trigger a repeat of the previous sharp selloff. West noted that the market now more clearly recognizes that even a memorandum of understanding or temporary ceasefire carries considerable uncertainty over its long-term durability. With the situation at the Strait of Hormuz remaining deadlocked, geopolitical risks, high oil prices, and robust free cash flow at energy companies are jointly underpinning sector performance. If the current rally persists, US energy stocks could once again set fresh record highs.
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