Amid an increasingly tense geopolitical backdrop, the U.S. stock market's energy sector has experienced a surge that has exceeded market expectations. Data shows that over the past three months, the energy sector has been the top performer among the various sub-sectors of the S&P 500, driven by a near 6% rise in oil prices fueled by former President Trump's attempts to take over Venezuela's crude oil industry and threats of military action against Iran. Walter Todd, Chief Investment Officer at Greenwood Capital Associates, stated that the firm is overweight on the energy sector, believing it "offers attractive risk-reward at current levels, especially relative to broader market areas that have already seen significant gains over the past year."
Despite the rise in energy stocks, positioning in the sector remains below the historical median, according to Deutsche Bank, indicating persistent market uncertainty. Data compiled by Goldman Sachs Group's prime brokerage unit shows that hedge funds were net sellers of energy stocks last week, with the scale of net selling being one of the largest among all S&P 500 sectors. Concurrently, there is a widespread market expectation for significant crude oil oversupply this year.
There are reasons to believe that geopolitical tensions could sustain the energy sector's upward momentum. Some investors are optimistic about the upside potential for U.S. oil companies. On Monday, trading in bullish call options on oil surged, with volume hitting a record, due to market fears that tensions with Iran could escalate and disrupt crude supplies from the Middle East.
However, simultaneously, an easing of Middle East tensions could halt the rise in oil prices. On Thursday, oil prices recorded their largest single-day drop since June after Trump indicated he would delay retaliatory measures against Iran, while the S&P 500 Energy Index fell 0.9%. Furthermore, there is no guarantee that the U.S. pursuit of Venezuelan crude will yield results for American oil firms.
"If U.S. oil companies enter Venezuela, there is still a lot of work to be done; it could be a slow, gradual process, not a quick one," said Rebecca Babin, Senior Energy Trader at CIBC Private Wealth Group. "Considerations around capital allocation are also important. If U.S. oil firms deploy capital to Venezuela, it might come at the expense of other projects, rather than being entirely new, additional investment."
If history is any guide, geopolitical regime changes in oil-producing nations often presage significant oil price increases. Research from J.P. Morgan points out that since 1979, eight such events led to crude oil price increases of 30%, with peaks as high as 76%, typically having a lasting impact on the market.
Several major Wall Street banks have adopted a more positive outlook on oil prices. Citigroup recently raised its near-term baseline forecast for Brent crude to $70 per barrel, citing an expanded geopolitical risk premium related to Iran, along with persistent export disruptions in countries like Libya and Algeria. BloombergNEF outlined a more extreme scenario—suggesting that if Iran's exports were completely halted from February through year-end, Brent crude could average $91 per barrel by the end of 2026. The agency views this outcome as unlikely but still reasonable given the existing regional risks.
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