Volatility in oil prices has remained a defining feature of global markets ever since the onset of the Middle East conflict. Against this backdrop, energy ETFs continue to stand out as a segment where investors may consider increasing exposure, as crude prices remain highly sensitive to every headline surrounding potential negotiations between Washington and Tehran.
Earlier this week, growing optimism surrounding a potential peace deal briefly weighed on oil prices, as investors hoped a diplomatic breakthrough could ease supply concerns. However, the outlook for a near-term agreement has since become increasingly uncertain. Recent strikes have further complicated negotiations, while the continued closure and vulnerability of the Strait of Hormuz have once again brought the risk of prolonged supply disruptions back into focus, driving oil prices higher.
Oil prices rebounded on Thursday, climbing more than 2% after Iran’s Revolutionary Guards claimed responsibility for targeting a U.S. airbase in retaliation for an earlier American strike in Bandar Abbas, as quoted on Reuters. However, optimism surrounding a diplomatic breakthrough faded quickly after President Donald Trump denied reports that a compromise agreement with Tehran was near.
The rapid reversal in market sentiment highlighted the fragile and uncertain nature of ongoing peace negotiations, as renewed military tensions once again revived fears of potential supply disruptions and pushed oil prices higher. The latest developments also suggest that reaching a comprehensive peace agreement could take far longer than markets had initially anticipated.
As a result, investors may be better off avoiding sharp shifts in their outlook on energy ETFs based solely on short-term conflict-related headlines or temporary optimism surrounding diplomatic talks. Instead, maintaining a longer-term investment perspective may prove more prudent, particularly as structural and macroeconomic factors continue to support the energy sector. Beyond geopolitical uncertainty, tightening supply dynamics and growing expectations for higher-for-longer oil prices are all strengthening the broader investment case for energy ETFs.
Supply Shock Risks Continue to Loom Over Oil Markets
At the same time, the possibility of deeper supply disruptions cannot be ruled out, especially if tensions escalate further in the region. With oil markets likely to remain volatile and supply risks continuing to influence sentiment, energy ETFs could remain well-positioned to benefit from sustained strength in crude prices over the long run.
Adding to concerns over potential supply disruptions, Fatih Birol warned that global oil markets could enter a “red zone” during July and August. The International Energy Agency (IEA) head, as quoted on Reuters last week, said a combination of heightened summer fuel demand, declining stockpiles and limited Middle East oil exports may significantly tighten market conditions, potentially adding further upward pressure to crude prices in the months ahead.
Although Birol did not elaborate what a potential “red zone” scenario would look like, he indicated that the combination of pre-war oil surpluses, reserve releases and stockpile drawdowns may prove insufficient to stabilize supply conditions.
Why Higher Oil Prices May Become the New Normal
As quoted on OilPrice.com, experts have warned that if disruptions and blockades in the Strait of Hormuz persist for an extended period, Brent crude prices in the $120 to $150 range could eventually become the new normal over the next several years. Analysts believe markets may still be underestimating the scale of the potential supply shock, particularly given the Strait’s critical role in global energy trade.
According to Edward Yardeni of Yardeni Research, even if the conflict eventually subsides, markets may continue to price in a persistent “Strait of Hormuz premium” in oil prices, reflecting the ongoing risk that Iran could once again use the critical shipping route as leverage in future confrontations, as quoted on Yahoo Finance.
Even under an optimistic scenario in which the Strait of Hormuz eventually reopens, traffic through the critical shipping route may take considerable time to normalize. In addition, damage to energy infrastructure across the region could require an extended recovery period, potentially keeping supply concerns elevated. Together, these factors may continue to support expectations for higher-for-longer oil prices.
Leveraged Energy Funds Worth a Look
Investors willing to take on higher risk and capitalize on prolonged uncertainty around diplomatic talks may consider increasing exposure to leveraged energy ETFs. However, given their structure, these instruments are best suited for short-term trading and require a disciplined investment horizon.
Investors can consider Direxion Daily S&P Oil & Gas Exp. & Prod. Bull 2X ETF GUSH, Direxion Daily Energy Bull 2X ETF ERX and ProShares Ultra Energy DIG.
Energy ETFs to Watch Amid Long-Term Oil Tailwinds
For investors unwilling to take on the added risk of leveraged energy ETFs, a more prudent approach may be to maintain a long-term bullish stance on oil and stay invested in energy ETFs. This allows participation in a higher-for-longer price environment while avoiding short-term, headline-driven volatility.
Investors can consider State Street Energy Select Sector SPDR ETF XLE, Vanguard Energy ETF VDE and State Street SPDR S&P Oil & Gas Exploration & Production ETF XOP.
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State Street Energy Select Sector SPDR ETF (XLE): ETF Research Reports
Direxion Daily Energy Bull 2X ETF (ERX): ETF Research Reports
State Street SPDR S&P Oil & Gas Exploration & Production ETF (XOP): ETF Research Reports
Vanguard Energy Index Fund ETF Shares (VDE): ETF Research Reports
This article originally published on Zacks Investment Research (zacks.com).