Chopping along.  August was another positive month for overall markets and the energy sector.  The S&P500 gained +2.0%, the Nasdaq Composite added +1.7% and energy outperformed nicely at +3.6% (S&P 1500 Energy, S15ENRS).  August’s energy subsector performance was as follows:  Oilfield Services +5.4% (OIH), Upstream +3.8% (XOP), Midstream -0.6 % (AMZ), and Clean Energy +7.3% (ICLN). Front month WTI gave back July’s gains, declining -7.6% to ~$64/bbl.  Natural gas rallied hard in the last few days of August to close -3.5% (~$3/ mmbtu)⁽¹⁾.

ENERGY MACRO

Dark clouds continue to swirl on the horizon for oil.  OPEC+ production increases are likely to result in meaningful inventory builds through the end of 2025 and 1H 2026.  Lower prices should help spur some incremental demand on the margin, but nothing dramatic enough to avoid price malaise/declines.  A recent Morgan Stanley research report was entitled “Heading for the Most Anticipated Surplus”.  Well said.  Most oil market participants and barrel counters are nervous (us obviously among them).  Short positions in WTI by financial players are around a 15 year high.  Often, when something becomes so consensus, it winds up being a non-issue.  Doom-and-gloom around Y2K was a stock market frenzy for 18 months, but was ultimately a nothingburger because “the market” had anticipated and prepared.  Will oil be the same?

In our opinion, the oil market is having a bit of a boil-the-frog moment.  OPEC+ incremental volumes have been well telegraphed, beginning almost six months ago.  Six months is a long time.  Since then, we’ve had a tariff scare, actual tariff implementations and a 12 Day War in the Middle East.  Oil now sits in the low $60’s.  Given the fear of worse (and the short-lived, Liberation-induced reality of worse), low $60’s doesn’t seem that bad.  Given the drilling efficiencies that are allowing E&P companies to reduce capex without cutting activity, low $60’s doesn’t seem that bad.  Given the fact that energy company valuations are already inexpensive, low $60’s doesn’t seem that bad.  But the frog is boiling.  Oil is in the low $60’s because the fundamentals aren’t great and the market is oversupplied.  And it is going to get even more oversupplied.  Eventually, the boiled frog dies.  Now is not the time to be complacent.

With that depressing set of paragraphs out of the way, let’s now turn the argument on its head by time traveling to Summer 2026 and make the assumption that WTI oil prices never dipped into the $50’s and averaged $65-$75/bbl from August 2025 to Summer 2026.  What events would have occurred to create this outcome?  Said another way, what near-term variables can make our current crude price forecast much too pessimistic?

•  OPEC+ production additions don’t materialize – A big part of the bear case for oil revolves around OPEC+ supply growth.  What if the next wave of supply additions simply doesn’t happen?  Maybe they are a ruse by OPEC+ to satisfy US President Trump’s demands.  OPEC+ delivered the words, but maybe they don’t deliver the barrels.

•  OPEC+ shifts to cuts – Whether because of a) “objective accomplished” behavior around Iran/Trump or b) a change of philosophy or c) fiscal needs to build ski resorts in the desert, a shift by OPEC+ to remove barrels would certainly be an unexpected and positive catalyst.

•  Demand acceleration – With Net Zero agendas shifting to the background, worldwide economic health and/or a reaction function to current low oil prices, perhaps demand growth will accelerate in 2026.  Rather than growing the expected +700-1,300kbopd, maybe demand will double that, absorbing OPEC+ incremental barrels and tightening the market.  A mere +2% demand growth would translate to +2.1mmbopd (compared to the +700kbopd IEA assumption, +1.1mmbopd EIA assumption and the +1.3mmbopd OPEC assumption).

•  An increase in inflation – This one is intriguing.  Typically, oil prices and inflation go hand-in-hand.  Oil often causes inflation.  However, completely unrelated to hydrocarbons, inflation could ramp in 2026.  If inflation ramps, investors will pigpile into investments that provide inflation protection….including oil.  Thus, oil could be an inflation bystander and still be pushed higher, simply from money flowing into the commodity complex…because that is what money does when inflation runs.

•  Supply disruptions – The Iran/Israel/US conflict in June did not result in actual supply disruptions, but it provided the playbook.  If Middle East tensions were to once again flair up, oil goes higher.  Or if Venezuela does something crazy around Guyana, oil goes higher.  Or if the Houthis get more aggressive/effective, oil goes higher.  Fill in the blank on the potential disruption, oil goes higher.  But it will have to be a real threat with real supply consequences.  The market has become jaded about supply “risks” over the past few years.  

•  Russia punishment gets real – Russia is a 9mmbopd producer, a 4.6mmbopd oil exporter and an exporter of another 2.5mmbopd of refined products.  Sanctions with teeth could make these exports more expensive or less available.  Recent datapoints have the risk of tougher sanctions decreasing, not increasing, but change can come quickly in the current geopolitical environment.      

•  Animal spirits – Sometimes things happen because they happen.  Perhaps, even in the face of higher near-term supply / inventories, the market may simply decide not to punish oil prices.  A new paradigm could emerge (higher prices at any given level of inventory).  This would most likely be due to some embedded optimism around future demand growth (perhaps with AI productivity as the driver), or a recognition of impending supply challenges (a function of maturing US shale productivity and low levels of global exploration activity).  We’ll be able to explain it in hindsight, but it will be a mystery in process.

Turning to natural gas, the wildly bullish sentiment of 1H 2025 is nervously wavering as we move through Q3 2025.  Front month NYMEX has fallen from a high of ~$4.50/mmbtu in March 2025 to ~$2.95/mmbtu as this note goes to print (a correction of -33%).  Calendar 2026 and calendar 2027 futures have dropped -14% (to ~$3.90/mmbtu) and -4% (to ~$3.90/mmbtu), respectively.  US production has been surprisingly high, with Q2 volumes pegged at 107+bcf/day versus expectations in the 105-106bcf/day range.  Many who model natural gas have had trouble reconciling the production data to drilling and fracking activity and the supply/demand data to weekly/monthly storage.  Regardless of whether it is poor data quality or too many molecules, softer prices are a near-term reality.  As such, we expect Q3 conference season (and Q3 earnings reports) to be filled with publicly traded E&P companies reiterating their commitment to capital discipline.  We’ve always felt natural gas was a 2026 story based on LNG demand growth – and we remain 2026 gas bulls.  Skating through 2025 with no hiccups was too good to be true, but we remain optimistic about the forward outlook.  Perversely, we are encouraged that expectations have been lowered/reset.  It will just make for better momentum down the road.

INDUSTRY DYNAMICS

•  Exploration success for TALO – We were happy to see Talos announce an exploration success in the Gulf of Mexico in August.  It’s the perfect excuse to highlight that exploration is somewhat of a lost art amongst energy investors of today.  For the past 20 years of the shale era, assessing success for an upstream company meant divining the number of acres, number of benches, drilling density, frac stages and initial decline rates, all to load up an excel spreadsheet.  With exploration, the conversation is different, with words like oil/water contact, traps, seals, etc.  Not immediately, but not far away, we are going to have to re-learn the exploration vocabulary as shale matures and the world looks to other sources for the next 10mmbopd of 2030s and 2040s demand.

•  The deals just keep coming – Some folks didn’t take the summer off.  In Canada, Cenovus and MEG Energy did a $7B deal to put two heavy-oil players together.  In the US upstream industry, small caps Crescent Energy and Vital Energy announced a combination.   While the stock market is generally ignoring energy, energy companies are taking action.  We suspect there will be at least a dozen fewer publicly-traded OFS and upstream names by this time next year.  The average company in the sector will be bigger, have a better cost structure (both operating costs and G&A) and a better balance sheet.  The upside spring is quietly coiling.

ENERGY EQUITIES

We’ve harped for the past several years about technology stocks dominating investor mindshare and money flow.  During June, energy’s outperformance during the 12 Day War showed us what can happen when investors pay attention.  However, with tech’s strong Q2 results and energy’s commodity doldrums, a big, sustainable sector rotation feels unlikely in the near-term.  Value, capital returns and capital discipline remain the virtues of the energy sector.  Patience remains the virtue of energy investors.

As always, we welcome your questions and comments.

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(1) Bloomberg