Recently, oil prices have been fluctuating at very high levels, driven by the dual impact of the Russian-Ukrainian war and the Fed raising interest rates. On March 17, the Federal Reserve decided to raise interest rates by 25 basis points (or 0.25%), raising the target range of the federal funds rate to 0.25% to 0.5%, in line with market expectations. It was the first time the Fed has raised interest rates since 2018. Inflation in the U.S. was at record highs ahead of the Fed rate hike. With crude oil prices rising sharply, many expect the high oil prices to persist as it is difficult to predict when the geopolitical situation will be resolved.
Russia is the world's third-largest oil producer after the United States and Saudi Arabia. Even if there is a ceasefire between Russia and Ukraine, crude oil prices could remain high due to the sanctions imposed on Russia by western nations. Therefore, Russian crude oil may not be available in the international crude oil markets for a while. The surge in international oil prices this year was astounding at the beginning, directly driving energy stock prices higher. Furthermore, energy stocks are traditionally regarded as defensive investments, which could attract investors' attention in volatile market conditions.
Energy stocks gain traction
The significant crisis created by the Russian-Ukrainian war doubled the appeal of energy stocks. Among the 11 S&P 500 sectors, the energy sector was the best performer in 2021, with a cumulative gain of over 40%. The sector has risen by more than 30% this year. Shares of Occidental Petroleum Corp doubled in 2022.
Chevron (NYSE: CVX) is up 32% this year with a 3.58% dividend; ConocoPhillips (NYSE: COP) is up 30% this year with a 2.45% dividend; Exxon Mobil (NYSE: XOM) ) is up more than 20% this year with a 4.5% dividend yield; Shell (NYSE: SHEL) is up more than 12% this year with a 3.56% dividend yield.
Other investment products worth watching are energy ETFs. For example, the Energy Select Sector SPDR exchange-traded fund (XLE), which tracks energy stocks on the S&P 500, has risen more than 30% this year; The United States Oil Fund ETF (USO) has risen 38% this year.
The US Dollar Index Fell Short-Term Support for Oil Prices
Generally speaking, rising interest rates will increase the attractiveness of US dollar assets and help overseas capital return to the US domestic market, thus providing strong support for the US dollar index to rise. Commodities are generally denominated in US dollars, so there is a clear negative correlation between the US dollar and crude oil prices.
The U.S. dollar index has been trending higher since the outbreak of the Russian-Ukrainian war, with market participants betting on more hawkish Fed policy. However, since the actual rate hike was much lower than market expectations, the dollar index did not rise after the announcement of the first-rate hike but instead fell unexpectedly by 0.6% on that day. Nevertheless, the move provided some short-term support for crude oil prices. On March 18, one day after the rate hike, international crude oil prices rebounded sharply by over 8% to close back above $100 per barrel.
Is There Still an Upside for Energy Stocks in the Future?
Since the main factor behind the rising oil prices comes from the supply side, the impact of interest rate hikes on oil prices is relatively limited and will not change the overall trend of high oil prices in the short term, but there may be temporary shocks.
This year, tensions on the crude oil supply side will continue supporting oil prices. After several rounds of negotiations between Russia and Ukraine, the tensions have not escalated further, and the rise in oil prices has subsided. However, if supply disruption concerns persist, crude prices could rally to new highs. Therefore, oil stocks have room to keep rising depending on the sanctions on Russia.
Russia could cut its exports of oil and petroleum products by 3 million barrels a day starting next month, the International Energy Agency (IEA) said, a gap that would be far greater than the 1 million barrels a day reduction in demand expected due to rising fuel prices. Affected by the news, Morgan Stanley raised its third-quarter Brent price forecast by $20 to $120 a barrel.
Analysts at UBS had higher expectations for oil price gains, telling the media that the short-term forecast for Brent is $125 a barrel, which is a soft ceiling for prices. However, if supplies deteriorate or persist for longer, prices may rise further. Brent crude could reach $150 a barrel if the war continues.