With turmoil in the Middle East dominating headlines, many investors are wondering what the recent and growing unrest in the region means for oil prices and for equity portfolios.

While I certainly can’t predict the outcome of events in the Middle East, oil prices are likely to remain toward the upper end of their recent range for the foreseeable future given current supply and demand dynamics. Even without a sustained spike in oil prices, there’s a strong case for sticking with energy stocks simply based on valuations.

First, here’s a quick look at my expectations for oil supply and demand. Currently, oil prices remain elevated because global demand has continued to climb, despite slower growth in China, and supply overall has been unexpectedly constrained by both geology and geopolitical unrest. Looking forward, oil supply is likely to remain constrained and oil demand is likely to continue to grow.

Oil supply: There’s a good chance that future oil supply may be tighter than expected. Currently, oil prices remain in a somewhat precarious balance, supported by a long-term rise in North American production, but at the mercy of falling production and exports in much of the Middle East and Africa.

However, U.S. production growth is likely to decelerate in the coming years, placing more of a burden on OPEC, where rising geopolitical risks put supply increases in jeopardy. In other words, at a time when stable North American production will be decelerating, there will be an increasing call on production from the most unstable parts of the world, particularly Iraq. This in no way suggests that the world is somehow “running out of oil,” but it does mean that given the low likelihood of a clear resolution in the Middle East, supply is likely to disappoint.

Oil demand: Meanwhile, oil demand is likely to continue to rise. Over the long run, economic activities and population growth are the key drivers of oil demand. While oil demand in developed markets is likely to remain soft on the back of improving efficiency and slower secular growth, increased demand in emerging markets — driven by urbanization and increasing car ownership — will probably offset this trend.

As for what this means for investors, even without the prospect for higher oil prices, I would maintain an overweight exposure to energy stocks simply based on valuations. Despite outperforming year-to-date, energy sector valuations still have room to grow, as measured by looking at the S&P Global 1200 Energy index. Multiples are still at a discount to their 10-year average and fund positioning is low, as I point out in my new Market Perspectives paper. In addition, I continue to see good free cash flow and several recent investment projects are beginning to bear fruit.

Source: Market Perspectives piece “Oil’s Precarious Balance

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog and you can find more of his posts here.

Investopedia and BlackRock have or may have had an advertising relationship, either directly or indirectly. This post is not paid for or sponsored by BlackRock, and is separate from any advertising partnership that may exist between the companies. The views reflected within are solely those of BlackRock and their Authors.


Related Articles
  1. Savings

    Easy Ways to Go Green and Stay Budget Friendly

    Social entrepreneurs recruit "skeptics" to team green, by providing economically efficient products and services that minimize consumers' carbon footprint.
  2. Investing

    Top Investment Banks In The Energy Industry

    Many global Investment banks are highly involved in the energy industry, but there are also some smaller banks and boutiques that are strong players.
  3. Stock Analysis

    The 6 Biggest Russian Energy Companies

    Learn about the top energy companies in Russia, a country that holds some of the largest reserves of oil, natural gas and coal in the world.
  4. Economics

    The Biggest Oil Towns in North Dakota

    Learn how the oil boom in North Dakota has transformed two small towns from sleepy agricultural outposts to booming centers of industry almost overnight.
  5. Investing News

    Oil Prices Expected to Surge in 2017

    Oil has made headlines for its plummeting prices this year. When will prices rise again?
  6. Stock Analysis

    The Biggest Oil Producers in Asia

    Learn which Asian countries deliver the most crude oil to market, and discover what companies are the biggest producers in each country.
  7. Stock Analysis

    The 5 Biggest Russian Oil Companies

    Discover the top Russian oil companies by production volume and find out more about their domestic and international business operations.
  8. Economics

    The US States That Produce the Most Oil

    Learn what eight states produce over 90% of U.S. oil, and how fracking has helped the United States become the world's largest oil-producing nation.
  9. Stock Analysis

    3 Solar Stocks to Add to Your Portfolio

    Understand the growth and challenges of the renewable energy market and its success in 2015. Learn about the top three energy stocks to add to a portfolio.
  10. Stock Analysis

    The 5 Best Buy-and-Hold Energy Stocks

    Understand why energy companies' stock are volatile when oil prices are volatile. Learn about the top five energy companies to buy and hold.
  1. How much oil must be produced to maintain inventory levels in the United States?

    Domestic energy investors should track the reserve inventory of crude oil for the United States, which is released in a weekly ... Read Full Answer >>
  2. To what extent is the oil and gas sector dominated by a few major companies?

    Oil and gas are two expansive and highly diverse product lines, with active competition domestically and internationally. ... Read Full Answer >>
  3. Do all oil companies received the quoted price of West Texas Intermediate for their ...

    The quoted, or spot, price of West Texas Intermediate, or WTI, crude oil is just one of several benchmark oil prices. The ... Read Full Answer >>
  4. How do the costs of oil sands producers compare to traditional drillers?

    The oil sands of Canada are some of the most expensive crude oil assets in the world to produce. Each asset type, such as ... Read Full Answer >>
  5. How do the average costs compare for the different types of oil drilling rigs?

    Average costs vary widely between different types of oil rigs, starting at around $20 million and ranging as high as close ... Read Full Answer >>
  6. How long does it take an oil and gas producer to go from drilling to production?

    Depending on the depth of drilling required and the type of drilling method used, a standard oil well can commonly advance ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  2. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  3. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  4. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  5. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  6. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!