How does the oil price affect my investments?
The value of your investments and the income you receive from them can go up and down, and you may get back less than you invest. Any examples are for illustration purposes only.
Swings in the oil price, spurred on by the developing narrative around conflict in the Middle East, have reminded investors just how far the ripples extend when it comes to the strategic influence of black gold.
We might have spent the past few years imagining a future without such a dependence on fossil fuels but, for now, oil still plays a critical role in the global economy. This particular story might be changing by the hour but it’s worth stepping back and reassessing the broader reach of the oil price and why it might have found its way into your portfolio without you knowing.
Oil stocks: dominant dinosaurs?
The most obvious impact of a gyrating oil price is on the companies getting it out of the ground and onto the garage forecourts. Together, BP and Shell make up over 10% of the FTSE 100’s market cap so when the world gets worried that supply streams might be disrupted, lifting the oil price in the process, these stocks can see a rise too. That can end up in a boost for the UK market, such is their weight in the index.
The US oil majors - ExxonMobil, Chevron and ConocoPhillips - can react similarly but, given they make up around 3% of the more tech-heavy S&P 500 index, that market effect is often more muted. It means that, even if you’ve opted to invest through a passive fund like an ETF (exchange-traded fund) tracking the UK or US market, you’ll probably still see an overall effect. That’s especially true as the impact of a fluctuating oil price doesn’t just end with the drillers and suppliers.
Energy costs seep across the market
Higher prices have very real consequences for airlines, logistics firms, industrial manufacturers and any firm burning through fuel to keep the company’s engine running. Some sectors, like airlines, are always trying to hedge future fuel costs through both options and futures contracts because they are much more likely to see margins tighten when fuel costs rise. It’s not unusual to see the market marking their shares down as a result of being some of the most exposed industries to a hike in oil prices.
Then there are the knock-on effects of prices rising at the petrol pumps. The extra cost to companies tends to get passed on to the consumer, driving up inflation and leaving less in our pockets to spend on those ‘nice to haves’ like meals out or a new outfit. It means a rising oil price can have an indirect effect on the consumer discretionary sector, simply because the car is a bit thirstier or the necessary shopping is getting more expensive.
Oil, inflation and interest rates
If oil-driven inflation contributes to an overall inflationary rise, central banks can start raising interest rates in an effort to combat price rises. That higher rate can have a negative effect on stock prices - particularly those of high-growth companies whose profits are expected to come in the future. The domino effect can become quite pronounced, especially if the oil price keeps rising on the back of sustained disruption to production.
Oil price worries: where are we now?
Given the stop-start nature of attacks and ceasefires, the oil price has been snaking up and down but hasn’t broken the broad range of ceiling and floor prices since around 2023, even falling in the past day or so as tensions seemingly de-escalate. So far, these movements have been sudden but not outlandish in magnitude, mostly thanks to a lack of disruption in the Strait of Hormuz. Iran having the capability to choke off supply in the sea passage connecting the Persian Gulf to the open ocean has made market-watchers nervous but, as long as it remains open, investors seem content enough to keep a cool head.
It’s unclear how likely a closure of the Strait would be, given 84% of the crude oil that left the area went to Asian markets, including China and India, in 2024. While it may serve as a symbol of disruption to Western markets, it is the East that would most likely be affected, according to the US Energy Information Administration (EIA). In that case, it could end up doing more harm than good.
Important information
When investing, your capital is at risk. The value of your investments, and the income you receive from them, can go down as well as up and you may get back less than you invest. Forecasts aren’t a reliable guide to future results or returns.
Make sure to do your own research on what investments are right for you before investing or consider seeking expert financial advice. Please note that this article is meant for information and does not constitute any financial advice. This is not an offer, recommendation, inducement or invitation to buy, sell, or hold any securities, or to engage in any investment activity or strategy.
