The Mideast energy shock’s next phase

Brent crude oil surged back to around $117 a barrel last week, its highest since April. But oil prices tell only part of the story of how the energy shock has evolved. The initial disruption centered on crude supply, but rerouted shipments, inventories and strategic reserves helped absorb much of the shock. Now scarcity has shifted downstream. Even as crude supplies recover, refining and shipping bottlenecks have pushed the delivered cost of fuel from the Middle East to Asia to more than twice prewar levels. This helps explain why shares of refiners have jumped some 160% this year, while shares of tanker operators have climbed 120%. See the chart. Both have far outpaced the 40% gain in major oil and gas producers, even as energy has become the top-performing sector globally. But after such sharp gains, how much further these stocks can run depends on which bottlenecks persist, even if the conflict ends.

Global growth has held up thanks to strong AI investment and government spending. Much of the initial inflation shock is already reflected in headline inflation, but higher fuel costs are starting to feed into some core inflation categories. As we’ve previously noted, the energy shock has uneven effects: we estimate it’s reduced GDP by about 0.5% in Europe, compared with just 0.1% in the U.S. Those differences could become even more pronounced. Europe looks particularly vulnerable, with natural gas storage at around 75% – its lowest seasonal level since recordkeeping began in 2011 – while disrupted supplies of liquefied natural gas complicate efforts to rebuild reserves. A colder winter could push European energy prices, already up 170% this year, higher. The U.S. is better insulated as a net energy exporter, while strong tech exports have cushioned Asia from higher import costs. The shock’s uneven impacts are accelerating efforts to bolster energy resilience and security.

Selectivity is key

That is creating new investment opportunities – but at a cost. The geopolitical fragmentation mega force we’ve long described reinforces this shift, raising the value of infrastructure that protects against future shocks. Energy importers are diversifying both traditional fuel supplies and electrification, underscoring the energy transition and resilience mega force. Exporters, including those in the Middle East, are investing in alternative routes to bypass vulnerable chokepoints. We see this as a structural shift that could outlast the conflict. Yet building these contingencies requires substantial investment, which could intensify competition for capital and put further upward pressure on sovereign bond yields.

We favor opportunities where energy constraints and profit margins look durable and valuations remain attractive. For now, existing energy equity exposures could deliver strong earnings as oil prices and refining margins stay elevated. But after this year’s oil rally, we also see opportunities in select U.S. and European utilities hit by rising bond yields. In bonds, higher yields support our recent upgrade to U.S. Treasuries. We prefer short-term bonds for income, as growing energy security investment could increase competition for capital and push longer-term yields higher.

Our bottom line

The Mideast energy shock is exposing longer-term constraints that could outlast the conflict. We favor selective exposure to energy infrastructure and short-term income over broad market bets.

Tech stocks swung sharply last week as investors stepped up scrutiny of the AI trade, pushing the Nasdaq down roughly 1% despite strong earnings from some of the sector’s biggest names. The S&P 500 fell 0.4%, with a rotation into defensive sectors helping limit losses. U.S. 10-year Treasury yields slipped below 5% as investors sought refuge from the tech selloff. Brent crude oil touched a six-month high of $117 a barrel on concerns about further disruption to Middle East energy flows.

The Federal Reserve’s interest rate decision takes center stage this week after a hotter-than-expected September CPI report showed price pressures broadening. Even as we expect another hike by year-end, we don’t view recent tightening as the start of a sustained hiking cycle. Markets have partially scaled back expectations for further hikes since the September meeting, moving closer to our view.