Assessing the Geopolitical Risk Premium in Energy and Defense Sectors Amid Rising Middle East Tensions

The Middle East has long been a fulcrum of global geopolitical risk, but the 2025 escalation of tensions-particularly the Israel-Iran conflict-has intensified its impact on energy and defense markets. As of late 2025, the interplay between acute supply uncertainty and strategic asset allocation has become a defining challenge for investors. This analysis examines how the embedded geopolitical risk premium in these sectors has evolved and offers actionable insights for navigating the volatile landscape.

The Energy Sector: Volatility Amid Structural Abundance

The energy market's response to Middle East tensions in 2025 has been marked by paradoxes. While global oil supply remains structurally abundant, the psychological pricing effect of geopolitical risks has driven sharp volatility. For instance, oil tanker rates surged by 40% since June 13, 2025, reflecting heightened risk premiums in the shipping industry. Oil prices spiked to $80 per barrel during the 12-day Israel-Iran war in June, though the market stabilized quickly due to U.S.-brokered resolutions.

The BlackRock Geopolitical Risk Indicator (BGRI) underscores the broader context: elevated risks from U.S.-China competition, cyber warfare, and potential terror attacks have created a persistent overhang. Even as actual supply disruptions remain limited, the market's "standing risk premium" for energy has become a structural feature. This is evident in the Strait of Hormuz, where 30% of global seaborne oil flows remain vulnerable to closure.

The Defense Sector: Resilience and Innovation as Hedges

In contrast to energy's volatility, the defense sector has demonstrated resilience. U.S. defense budgets surpassed $1 trillion in 2025, with global demand for missile defense, electronic warfare, and surveillance technologies surging. Defense ETFs, such as the U.S. Global Technology and Aerospace & Defense ETF (WAR), saw $4.2 billion in inflows during the April 2025 strikes, while travel ETFs faced $1.1 billion in outflows.

However, the sector's performance is heterogeneous. A study of 75 global defense companies found that 81.4% were impacted by the Russia–Ukraine war, with U.S. firms acting as robust hedges between 2021 and 2022. European and Chinese defense stocks, meanwhile, showed varying sensitivity to geopolitical risks, highlighting the importance of innovation as a driver of performance.

Strategic Asset Allocation: Balancing Risk and Resilience

Investors have adopted a dual strategy to mitigate Middle East-related risks: diversifying into defensive assets and rebalancing portfolios toward resilient sectors. Gold, a traditional safe-haven, surged to $4,002.92 by October 2025, reflecting a 52.52% year-to-date increase. Platinum, with its dual industrial and monetary demand, outperformed gold, rising 73.46% year-to-date.

U.S. Treasury bonds also gained traction as investors sought liquidity and stability. During the April 2025 strikes, 10-year Treasury yields dropped by an average of 58 basis points. Geographical diversification has further been prioritized, with European markets attracting capital due to increased defense spending and a weaker U.S. dollar.

Hedging Strategies: From Traditional to Alternative Assets

The 2025 crises have accelerated the adoption of hybrid hedging strategies. Real assets like infrastructure and commodities have been paired with digital assets such as Bitcoin, which saw renewed interest amid market fragmentation. Green bonds, too, have emerged as a tool for mitigating geopolitical risks, with their positive returns during inflationary shocks making them a compelling addition to diversified portfolios. For energy markets, traders are leveraging real-time liquidity analysis tools to navigate volatility. Meanwhile, the "geopolitical premium" in oil pricing-reflecting psychological rather than physical supply risks-has become a key consideration for hedgers.

Conclusion: Navigating the New Normal

The 2025 Middle East tensions have cemented a new era of geopolitical risk as a structural element in global markets. For energy, the challenge lies in balancing short-term supply diversification with long-term energy transition goals. For defense, innovation and regional dynamics will dictate sector performance. Investors must prioritize liquidity, diversification, and a mix of traditional and alternative assets to hedge against uncertainty.

As the U.S. reshapes its geopolitical relationships and global defense spending reaches $2.7 trillion, the energy and defense sectors will remain central to strategic asset allocation. The key is to embed a standing risk premium into portfolio design, ensuring resilience in an era of persistent volatility.