Why Oil Prices Are Understating Geopolitical Risks: A Tactical Play in Energy Equities

The escalating Iran-U.S. conflict, amplified by President Donald Trump's bellicose rhetoric, has not yet translated into the oil price spikes markets historically associate with Middle East instability. Despite fears of a Strait of Hormuz closure or Iranian retaliation, Brent crude remains stubbornly anchored near $75 per barrel—a stark contrast to the $115 peaks seen during the Russia-Ukraine war. This divergence presents a paradox for investors: why are energy markets so sanguine about a conflict that could disrupt 20% of global oil flows? And more importantly, where are the hidden opportunities in this underreaction?

The Anatomy of an Underreaction

Strategic Reserves and OPEC+ Flexibility
The U.S. EIA's June 2025 report reveals crude inventories have dipped 10% below the five-year average, yet strategic petroleum reserves (SPR) have inched up to 402.3 million barrels. This combination—lower commercial stocks but a robust SPR—gives markets a safety net. Meanwhile, OPEC+'s recent decision to maintain production cuts until 2026 ensures supply discipline. Unlike the 1990 Gulf War, when OPEC's cohesion was tested, today's cartel is unified, with Saudi Arabia and Russia coordinating to stabilize prices.

Market Scepticism of Military Escalation
Trump's threats—such as targeting Iran's Fordow facility—have been met with muted trading. Analysts note that direct U.S. involvement would risk a global oil shock, which the administration seeks to avoid given its 2024 election calculus. Historical precedents support this caution: during the 1980 Iran-Iraq War, prices surged only after Saudi Arabia intervened to compensate for lost supplies. Today, OPEC's spare capacity (6-7 million bpd) acts as a buffer, keeping traders from panic buying.

Historical Context: Why This Crisis is Different

Past Middle East conflicts triggered sharp price spikes: the Iran-Iraq War saw crude jump 30%, while the 1990 Gulf War drove prices to $40 per barrel in weeks. Yet today's market differs in three key ways:
1. Global Supply Diversification: U.S. shale, Canadian oil sands, and Brazilian pre-salt fields now provide 15 million bpd of non-OPEC supply—versus 7 million bpd in 1990.
2. Strategic Reserves: The U.S. SPR is 40% larger than in 1991, while China's commercial stocks have tripled since 2015.
3. Demand Softness: IEA data shows global demand growth is now 720 kb/d (2025), half the 1990 pace, limiting upward price pressure.

The Investment Case: Tactical Bets in Energy Equities

The underreaction creates a buying opportunity in energy equities, particularly refining and midstream plays, which benefit from stable crude prices and refining margin expansion.

ETF Plays: The XLE Opportunity

The XLE, down 12% YTD, now trades at a 30% discount to its 2022 highs. With U.S. refining margins averaging $18/bbl (vs. $5 during the Russia-Ukraine war), refiners like Marathon Petroleum (MPC) and Valero (VLO) are positioned to thrive. The ETF's 2.5% dividend yield provides downside protection.

Geopolitical Gamma: A Refiner's Edge

Iran's inability to retaliate effectively—due to U.S. naval dominance—means most attacks will target infrastructure, not chokepoints. This benefits U.S. refiners, which can source discounted crude from Iran's neighbors (e.g., Saudi Arabia) while selling refined products at global prices.

Risks: Navigating Geopolitical Volatility

The market's complacency is a double-edged sword. A Strait of Hormuz closure or Iranian drone strike on Saudi facilities could spike prices to $100+/bbl overnight. Investors should:
- Cap exposure: Allocate no more than 5% of a portfolio to energy equities.
- Use stop-losses: Set below $60/bbl for oil-linked positions.
- Avoid pure-play E&P stocks: Companies reliant on Iranian crude (e.g., TotalEnergies) face outsized risk.

Conclusion

The current Iran-U.S. standoff is a classic case of market myopia—traders are pricing in short-term stability while ignoring tail risks. For investors willing to take a measured stance, energy equities offer asymmetric upside: refiners and midstream operators can deliver 15-20% returns in a normalized scenario, while the XLE's valuation leaves room for multiple expansion. However, this is not a “set it and forget it” trade. As the old adage goes: In energy markets, the best time to buy is when you're scared—but not yet terrified.

Actionable Takeaway:
- Overweight XLE to 5% of portfolio.
- Add refining stocks (MPC, VLO) for margin-driven upside.
- Avoid leveraged E&P names until geopolitical fog lifts.

The energy sector's underreaction is a gift for contrarians—but it's also a trap for the overconfident. Stay tactical, and keep one eye on the Strait of Hormuz.