Iran crisis highlights an emergent energy cycle
By Mark Lacey, Head of Thematic Equities at Schroders
There were signs that available oil supplies were likely to fall short even before the current conflict in the Middle East threatened unprecedented disruption. Energy equities remain underrepresented in global indices. If capital allocation to the sector increases during a sustained investment cycle, stronger earnings and improved sentiment could support share prices.
The effective closure of the Strait of Hormuz, through which roughly 20% of global oil is shipped alongside a significant share of LNG, has created a significant supply shock. Oil markets were already tightening, with gas markets expected to follow suit over the next three to four years. The conflict is now bringing forward the repricing.
We see this as the start of a long energy investment cycle with implications across energy markets. There are supply constraints in oil, gas and electricity markets on the one side, just as the demand profile is being pushed out on the other. As we enter an investment cycle we would expect to see cash flows and earnings appreciate and energy equities outperform. In the wider picture, as nation states rush to prioritise their domestic energy security, there are implications for renewables and associated technologies.
Capital has been leaving the sector
The energy sector’s weight in global equity indices has fallen from around 14% at previous cycle peaks to closer to 3% today. This shift followed a period of weak returns in the early 2010s, when companies invested heavily at high oil prices, and generated poor free cash flow.
Weight of MSCI World Energy in MSCI ACWI (%)
In response, investors demanded increased capital discipline, and management teams strengthened balance sheets and grew shareholder distributions. For several consecutive years, listed oil companies returned more cash to shareholders than they invested developing new supply.
Capital expenditure as a proportion of cash flow fell well below the levels of earlier cycles and has not meaningfully recovered. That restraint has had consequences.
Lack of investment has seen reserve lives fall
“Reserve lives” – which describe how long a company’s proven reserves would last at today’s rate of production – have shortened across much of the sector.
At the beginning of the 2000s they averaged 14 to 15 years; today for many producers the figure is between seven and ten. This reflects a prolonged period in which capital discipline favoured distributions over reserve expansion. Mature oil and gas basins, which have been developed for some time, continue to decline naturally. Maintaining output from these would need investment at a time when management teams have been reluctant to break their commitment to capital discipline.
Oil and gas supply growth is limited
Beyond 2026, there are fewer confirmed projects expected to add meaningful new production. Projected non-OPEC growth over the next few years is concentrated in Brazil, Guyana and Canada. US shale growth is slowing and production per well is no longer improving at previous rates. In the previous cycle, shale provided rapid supply response when prices rose, but that flexibility is now more limited, with incremental output increasingly capital intensive.
Global oil and gas capital expenditure vs oil price
AI and decarbonisation drive electricity demand
US electricity demand is expected to grow at roughly 2-3% annually for an extended period. One factor is the decarbonisation of giant sectors such as transport and heating. A separate, growing element of demand will also come from datacentres powering generative artificial intelligence (AI).
Historic and forecast global electricity demand in TWh
Many AI data centres – those which aren’t connected to the grid – are powered by gas turbines, and this is adding demand to major markets including the US where natural gas consumption is already rising.
Energy security becomes nation states’ top priority as they battle to secure supplies across oil, gas and renewables
Energy security was near the top of countries’ agendas before the Iran crisis. This means different things for different economies. For some, renewables will be a significant part of the answer.
This crisis does not change the long-term investment case for alternative energy: the cost profile of alternative energies was competitive before the conflict and remains so. Other factors, such as improving battery storage, are supporting the growth of specific energy markets.
But as in the oil and gas industries, there are supply constraints specific to alternative energy supplies.
Forecast global annual power capacity additions by technology
Conclusion: implications for investors
The current oil price reflects a supply shock occurring within a market shaped by a prolonged period of underinvestment. Electricity and gas demand are rising, driven by wider decarbonisation, AI and the increasing need for data centres, while reinvestment in new supply has lagged for more than a decade.
New supply requires sustained pricing and multi-year development cycles. Inventories remain within historical ranges and spare capacity is concentrated among a small number of producers. The market therefore has limited flexibility, leaving prices more sensitive to disruption. Even if prices stabilise, projects sanctioned today will take several years to deliver.
For oil producer equities, this combination of constrained supply, slower responsiveness and strengthening demand supports a more durable pricing environment. Earnings are highly sensitive to oil prices; balance sheets are stronger and leverage lower than during the previous cycle. As touched on previously, energy equities remain underrepresented in global indices. If capital allocation to the sector increases during a sustained investment cycle, stronger earnings and improved sentiment could support share prices.