What should investors do amidst the Iran oil shock? Here’s why it’s not just ‘buy oil’!

The Iran oil shock is not the first and won’t be the last, but still has investors perplexed at what to do. It is said that those who don’t learn from history repeat it, so we think the best thing to do is look at the past and see past oil shocks and predict what may happen in the sense of which stocks will gain and lose. It is easy to suggest it is just,’ Buy Oil!’ but it is more complicated than that.

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History may not repeat, but it does rhyme

Across modern financial history, major oil shocks have tended to follow a similar economic pattern: an abrupt disruption to supply or transport drives crude prices sharply higher, inflation rises quickly, and equity markets initially fall as investors price in slower growth and tighter monetary policy. The details vary, but the broad relationship between oil spikes and stock-market behaviour has been consistent across several decades.

Past oil shocks

Let’s look at a few modern oil shocks. The first followed the Arab–Israeli war in October 1973 when Arab members of OPEC imposed an embargo on countries perceived as supporting Israel. Oil prices rose from roughly $3 to nearly $12 per barrel within months. The shock fed directly into inflation across Western economies and contributed to the severe 1973–74 bear market.

Equity markets struggled for several years afterward as central banks tightened policy to contain inflation. Large integrated oil companies such as ExxonMobil and Chevron saw profits surge because their upstream production benefited immediately from higher prices. Oil-exporting states accumulated enormous financial surpluses that later became known as “petrodollars.”

Further oil shocks followed, one was in 1979 when Iranian oil production collapsed following the Iranian revolution. This one was a double whammy  because central banks (especially the U.S. Federal Reserve) pushed interest rates dramatically higher to break inflation. Our RBA could well follow suit.

A shorter but still dramatic shock happened when Iraq invaded Kuwait in August 1990, roughly 4–5 million barrels per day of supply were suddenly threatened. Oil prices doubled within a few months. Global stock markets fell sharply at first, with the U.S. market dropping about 20%, but the downturn proved temporary. Once it became clear that coalition forces would reopen Gulf supply routes, markets rebounded quickly. Energy producers rose during the spike, but the rally faded as soon as oil prices stabilised.

Two further worth noting included just prior to the GFC in 2007 to mid-2008 and then the when Russia invaded Ukraine.

So what can investors learn from past oil shocks?

The current geopolitical tension surrounding Iran resembles earlier supply shocks in several ways. Iran sits near the Strait of Hormuz, through which roughly a fifth of the world’s oil trade passes. Any disruption in that Strait immediately increases risk premiums in crude prices.

Markets typically react first with broad declines in equities, particularly in sectors dependent on fuel such as airlines, transportation, autos, and consumer discretionary firms. Energy companies, however, often move in the opposite direction because their revenues rise alongside crude prices.

So should you just buy oil producers amidst the Iran oil shock?

Not so fast! The biggest winners have not always been the companies that produce crude oil itself. Refiners, oil-field service firms, and defence contractors often outperform during these periods because they benefit from volatility in energy supply chains or from the geopolitical tensions that accompany them.

A group of companies that has historically tended to outperform during oil shocks includes ten particularly notable firms. These are ExxonMobil, Chevron, Shell, Valero Energy, Marathon Petroleum, Phillips 66, Schlumberger, Halliburton, Lockheed Martin, and BAE Systems. Now yes, the first three are big oil producers, but the next three are refiners. Then, Schlumberger and Halliburton benefit because high oil prices encourage more drilling and exploration activity, increasing demand for oil-field services.

And the last two are Lockheed Martin and BAE Systems which have nothing to do with oil at first glance. The pair appear on the list for a different reason: geopolitical crises that disrupt oil supply frequently coincide with rising defense spending and military demand.

Looking across all these episodes reveals several consistent lessons. Oil shocks usually trigger an immediate “risk-off” move in financial markets, pushing down most equities while energy stocks rise. If the price spike persists long enough, it tends to feed inflation and provoke tighter monetary policy, which eventually slows economic growth.

In extreme cases, such as the crises of the 1970s, oil shocks can contribute to recessions or stagflation. But if the disruption proves short-lived, as in 1990, markets often recover quickly once supply normalises.

Short term or longer term?

For investors evaluating the current situation involving Iran, the critical variable is duration. Short disruptions tend to create temporary volatility but little lasting economic damage. Prolonged disruptions—especially those affecting the Strait of Hormuz or multiple major producers—have historically produced deeper market stress while simultaneously boosting profits for certain energy and defence companies.

The first indicator is the physical supply disruption, measured in barrels per day removed from the global market. Oil markets can usually absorb small disruptions surprisingly well because spare capacity exists in places such as Saudi Arabia or the United States. Historically, when the disruption exceeds roughly 3–4 million barrels per day, the probability of a sustained oil shock rises dramatically.

In the current situation, traders are focused heavily on the vulnerability of the Strait of Hormuz because roughly 20% of globally traded oil passes through it. If shipping there were disrupted for weeks, the supply shock could become large enough to trigger the kind of macroeconomic stress seen in past crises.

The second indicator is the shape of the oil futures curve, especially whether the market moves into steep backwardation. This is not a term we made up, it is a term alluding to the situation where near-term oil contracts are much more expensive than those for delivery later. This usually signals immediate scarcity of physical supply. During the most severe oil shocks, the front of the futures curve rises dramatically relative to later contracts.

The third indicator is the energy share of global GDP, often approximated by how much consumers are spending on oil relative to total economic output. Economists have observed that recessions become more likely when oil expenditures rise above roughly 5–6 percent of global GDP.

Conclusion

Putting these three indicators together helps investors interpret the current environment. If the Iran situation produces only temporary disruptions and the Strait of Hormuz remains open, the oil spike may resemble the short-lived shock of 1990. In that case, equities often recover quickly after the initial sell-off.

But if shipping routes are disrupted, the futures curve steepens dramatically, and energy spending climbs toward recession thresholds, the situation could begin to resemble the structural shocks of the 1970s.