Mixed background SHP(-/-) mice are resistant to diet-induced obesity due to increased energy expenditure caused by enhanced PGC-1α expression in brown adipocytes. However, congenic SHP(-/-) mice on the C57BL/6 background showed normal expression of PGC-1α and other genes involved in brown adipose tissue thermogenesis. Thus, we reinvestigated the impact of small heterodimer partner (SHP) deletion on diet-induced obesity and insulin resistance using congenic SHP(-/-) mice. Compared with their C57BL/6 wild-type counterparts, SHP(-/-) mice subjected to a 6 month challenge with a Western diet (WestD) were leaner but more glucose intolerant, showed hepatic insulin resistance despite decreased triglyceride accumulation and increased β-oxidation, exhibited alterations in peripheral tissue uptake of dietary lipids, maintained a higher respiratory quotient, which did not decrease even after WestD feeding, and displayed islet dysfunction. Hepatic mRNA expression analysis revealed that many genes expressed higher in SHP(-/-) mice fed WestD were direct peroxisome proliferator-activated receptor alpha (PPARα) targets. Indeed, transient transfection and chromatin immunoprecipitation verified that SHP strongly repressed PPARα-mediated transactivation. SHP is a pivotal metabolic sensor controlling lipid homeostasis in response to an energy-laden diet through regulating PPARα-mediated transactivation. The resultant hepatic fatty acid oxidation enhancement and dietary fat redistribution protect the mice from diet-induced obesity and hepatic steatosis but accelerate development of type 2 diabetes.