Geopolitical Tensions Are Pushing Oil Stocks Higher, But Can the Rally Last?

The war with Iran has driven up oil prices, taking oil stocks up with them. Brent, the global crude oil benchmark, has rallied about 40% this year, rising from $60 to around $85 per barrel. That has fueled a more than 25% surge in the average oil company stock price this year.

Here's a look at whether the rally in oil stocks can last.

Image source: Getty Images.

The outlook for oil prices

Oil prices have surged this year due to the growing tensions with Iran, which has now boiled over into an armed conflict. The war with Iran threatens global oil supplies. In addition to being a major oil producer, Iran has retaliated by attempting to impede oil exports from the Persian Gulf.

About 20% of global oil supplies flow through the Strait of Hormuz, which borders Iran. The country has attacked crude-carrying ships passing through that key chokepoint. It has also used drones to attack oil infrastructure throughout the region. These attacks have driven up tanker shipping rates and caused insurance carriers to cancel coverage. Additionally, several energy companies have had to cut or suspend production due to safety issues or a lack of storage.

If Iran continues to impede the flow of oil out of the Persian Gulf or destroys key regional oil infrastructure, crude prices could top $100 a barrel. However, if there's a rapid de-escalation in the conflict, where Iran agrees to stop striking oil tankers in the Gulf, crude prices could begin deflating.

Riding the crude oil rally

The surge in crude prices is driving up oil company stock prices. For example, shares of U.S. oil and gas giant Occidental Petroleum (NYSE: OXY) have rocketed more than 30% while big oil behemoth ExxonMobil (NYSE: XOM) is up around 25%. Higher oil prices will enable these companies to make even more money.

The uptick in crude prices is an unforeseen boon for these companies, which had initially expected oil prices to remain lower this year. Occidental Petroleum has focused on becoming more efficient and paying down debt in recent years to generate more free cash flow at lower prices. That strategy had the company on track to produce an additional $1.2 billion in free cash flow this year at the same oil price as last year. It will now make even more free cash flow now that oil is higher, which could continue boosting its stock.

Meanwhile, ExxonMobil is in the midst of a multi-year strategy to grow its advantaged resources (lowest-cost and highest-margin), while continuing to execute its structural cost-savings initiative. Exxon's plan through 2030 would deliver double-digit annual earnings and cash flow growth at an average oil price of around $65 per barrel. Exxon would likewise make even more money if oil prices remain at or above current levels.

Oil prices could continue rallying in the near term

President Trump's current timeline is that the war with Iran will last four to five weeks, though he said it could go longer. The longer the war rages on, the more likely crude oil prices (and oil stocks) will continue rallying, since it likely means Iran will continue to target the oil industry in retaliation. However, a quick end to the hostilities could cause the rally to fade.

Matt DiLallo has no position in any of the stocks mentioned. The Motley Fool recommends Occidental Petroleum. The Motley Fool has a disclosure policy.