What the spike in oil means for investors

While the humanitarian impact of Russia’s invasion of Ukraine is the top concern, investors and consumers also continue to contend with challenges as the conflict intensifies. Perhaps the most immediate global impact is on energy prices. Oil prices have spiked in recent weeks to their highest levels since 2008, with Brent crude at one point trading above $125 per barrel. What implications might this have for investors and everyday consumers in the months to come?

The challenges created by the Russia/Ukraine conflict only add to the storylines of the past two years. During the initial stages of the pandemic lockdown, some oil contracts fell into negative territory. This had never occurred in history and was due to a lack of oil storage capacity driven by the collapse in demand caused by the COVID-19 pandemic. In other words, contract holders were so desperate to offload their oil that they were willing to pay others to take this otherwise valuable commodity.

We’re in the post-pandemic economy

The world has changed significantly since then. Over the past two years, oil prices have recovered alongside the economy, with a few bumps due to growth concerns and COVID-19 variants. As a result, higher energy prices have been a major contributor to rising inflation. The January Consumer Price Index report, for instance, showed that energy prices rose 27% over the previous year and gasoline prices skyrocketed 40%.

Chart: Gas prices have increased significantly, hurting consumer pocketbooks

Sources: Clearnomics, U.S. Energy Information Administration

From an economic perspective, energy affects everything. The world is still primarily driven by fossil fuels despite an increased focus on renewables among investors. The International Energy Agency (IEA) estimates that global oil demand will reach 100.6 million barrels per day this year, surpassing its pre-pandemic level.

Energy affects everything

While the dynamics of the oil and gas markets can be complex, there are a few simple ways in which energy prices affect investors. First, rising energy prices could propel inflation higher for some time. This hurts consumer pocketbooks and reduces discretionary income, effectively functioning as a tax.

Second, the energy sector of the stock market has benefited from the oil price recovery of the past two years. Energy stocks have done well, with the S&P 500 energy sector rising 37% year-to-date and 46% over the past 12 months. It is the only sector in the black this year and has far outpaced all other groups. These gains emphasize the importance of diversifying within and across markets.

Third, higher inflation and prices could act somewhat as a drag on the overall economy. While increases and collapses in oil prices have been correlated with bull and bear markets, this has more to do with their common connection to the economy. Oil prices tend to rise when growth is strong, as does the stock market. Thus, focusing on the underlying fundamental trends is ultimately more important when considering market performance over the course of years and decades.

An up-and-down market is in your future

There is likely uncertainty ahead for investors as the war in Ukraine plays out. However, investors are always faced with potential problems, whether it’s trade wars, pandemic, lofty valuations, rising interest rates, geopolitical conflicts, or other issues. Understanding the key issues while resisting the urge to overreact can help you achieve long-term financial success.