U.S. energy stocks are poised to outperform the broader market by the widest margin on record, driven by conflict in the Middle East and investors rotating away from highly-valued technology stocks. The S&P 500 Energy Index has surged 39% year-to-date in the first quarter, while the S&P 500 Index has declined by 7%. The sector has now advanced for 14 consecutive weeks, significantly surpassing the previous record of nine weeks set in 2007. Companies such as Exxon Mobil (XOM.US) and ConocoPhillips (COP.US) are on track for their best quarterly performance ever, with gains exceeding 40% over the first three months of the year.
The rally in energy stocks and crude oil prices has been sustained by supply constraints following disruptions in the Strait of Hormuz and attacks on energy infrastructure in the Middle East, events that followed the emergence of a new leader in Venezuela in January and the outbreak of conflict involving Iran in late February. Brent crude prices have soared 85% so far this year.
"The energy sector had been overlooked, but it's back in focus now, perhaps for unfortunate reasons," said Rob Thummel, a senior portfolio manager at Tortoise Capital. "This is a moment of realization for investors; maybe the recent crisis involving Iran proves it, but energy remains critically important." Energy stocks initially rose after U.S. actions regarding Venezuela's leadership and pledges to revitalize its oil industry.
According to Menno Hulshof, Head of Research at TD Securities, the momentum in energy stocks continued as investors began to scrutinize the impact of artificial intelligence on certain companies and shifted focus toward so-called "HALO" trades—referring to asset classes characterized by heavy assets and low obsolescence rates. "From a flow perspective, we are seeing significant capital move from sectors perceived as more vulnerable to AI disruption into many other types of high-risk sectors, including energy," Hulshof stated in an interview. "Against this backdrop, we've seen valuations in these sectors skyrocket; most of the sectors I follow hit record highs even before the Iran conflict emerged, and they are certainly overvalued now."
The sector's strength is also evident outside the U.S. The S&P/TSX Composite Energy Sector Index is set for its largest quarterly gain on record, outperforming the broader S&P/TSX Composite Index, with companies like Canadian Natural Resources and Suncor Energy posting increases of over 45%. The last time U.S. and Canadian energy stocks saw such significant gains was in the first quarter of 2022—following the outbreak of war in Ukraine. However, that outperformance was short-lived, with energy stocks beginning to decline a year later.
While geopolitics remain a primary driver for oil prices currently, the present situation is different. "Back in 2022, there was a consensus that the world would quickly transition away from oil and gas," Hulshof noted. "Now we are back in a market where attention is on long-tail resources, and their value is perceived to be far greater than previously expected." Tortoise Capital's Thummel pointed out that since 2022, energy companies have improved capital discipline and increased free cash flow yields, placing them on a stronger fundamental footing. Even if oil prices moderate slightly, energy firms are expected to benefit from the higher price environment. Analysts project that by 2026, companies like Chevron (CVX.US), Exxon Mobil, and ConocoPhillips could achieve prices up to $67 per barrel. With WTI and Brent crude both trading above $100 per barrel, even a 30% pullback would still provide room for earnings growth.
Furthermore, these companies stand to benefit from growing natural gas demand to power AI data centers. Meanwhile, according to Matt Portillo, Partner and Head of Research at TPH&Co., the energy business of Perella Weinberg, producers and refiners are expected to see increased cash flow, at least in the short term, due to higher oil prices, potentially using these funds for debt reduction or shareholder returns.
Long-term prospects for energy stocks are also improving. Portillo indicated that, despite ongoing conflicts, fundamentals remain supportive due to the need for nations to replenish strategic petroleum reserves depleted during the wars. Additionally, anticipated declines in U.S. shale oil production over the next decade are expected to help support energy prices. "Long-term, these stocks are still cheap; short-term, they have rallied significantly," Portillo said. "If geopolitical tensions ease, some pullback would not be surprising, but it could represent a healthy correction."
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