The world moves fast - August, September and early October were eventful in the energy patch. Ultimately, there has been no change to the general situation - the US/Iran conflict is now in its 8th month and continues to tighten the market on the margin (although less quickly than earlier in the year). Angst is rising along with higher prices. Our base case remains $75-$85/bbl crude over the next few years, a strong US power market, ample US gas supply and energy equities quietly performing despite lackluster investor interest.Below we hit a number of (what we deem to be) relevant topics that have come onto our radar screen over the past several months.

‍Iran Conflict

• Iran conflict intermittently more kinetic.  Despite the US headline shift from military pressure toward economic pressure, there have been plenty of missile launches, tanker strikes and escalation.  The Iranians fired missiles at US warships (not just tankers in the Strait of Hormuz) and Middle East airbases, while the US took out multiple Iranian-owned oil tankers.  The approaching US midterms elevate the risk, as seen in multiple high-profile tanker strikes over the October 9-11^th weekend.

• Economic pressure appears ineffective in the short term.  The US launched Operation Economic Outcast with the promise of much tougher sanctions on Iran.  Treasury Secretary Scott Bessent threatened “economic asphyxiation” of the Iranian regime.  While conditions within Iran are clearly not good, there is no evidence the regime is on the brink of collapse.  To date, there has been no visible action against Chinese banks (who enable Iranian financial activities).  Until there is, Economic Outcast appears to be more bark than bite in the short term.

• Strait of Hormuz tanker traffic has improved.  With help from the US military, more oil is getting out of the Middle East.  Volumes are now routinely 10mmbopd+ through the Strait.  Notably – Saudi Arabia is taking a shuttle-tanker approach, moving oil out on non-VLCC vessels and transferring that oil in the safer waters past the Strait.  Combined with exports out of the Red Sea, through the Suez and pipeline bypass through Fujairah, overall Middle East volumes are likely down only 2-4mmbopd from pre-conflict levels.  A dramatic improvement relative to the 10-15mmbopd declines early in the conflict.

• Beware the 42nd iteration of “a deal is imminent”…Iran isn’t budging.  WTI oil prices have pulled back from ~$105/bbl to ~$90/bbl as Strait volumes have increased and rumors intermittently surface of US/Iran negotiations.  We hear no willingness by Iran to give up on the various conditions that scuttled this summer’s MOU.  With decent volumes exiting the Middle East, the US seems less likely to cut a mediocre deal.  Result - status quo of uneasy conflict and (more gradually) tightening oil market.

• Higher Strait volumes are helpful to global crude markets and raise risk of Iranian retaliation.  Control of the Strait of Hormuz is Iran’s biggest geopolitical and military lever.  As the US trumpets the success of getting more crude out to global markets, it feels somewhat like sporting a big “kick me” sign.  Iran has boosted its tanker strikes in early October, which has been largely ignored/downplayed by the US political machine.

• Rise of the Houthis.  A two-front war has developed in the Middle East.  Iran is attacking almost everyone, while fighting the US.  Meanwhile, Iran’s proxy, the Houthis of Yemen, are attacking Saudi Arabia with substantial results.  The Houthis have captured several important points along the Bab-al-Mandeb Strait where the Red Sea exits to the Persian Gulf, while also launching multiple strikes against Saudi domestic targets (including the East-West pipeline and the Riyadh airport).  Will the US support Saudi and help to push back Houthi forces?  Will Europe get involved?  Will the Houthis keep blowing stuff up until oil prices push even higher?  In our opinion, the risk of a broader Middle East escalation is rising, not falling.

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Global Energy Markets

• Don’t look now, but 2027 crude oil is trading at $83+/bbl.  With a pervasive view that an end to the Iranian conflict is coming “soon”, crude oil futures have been steeply backwardated.  With front month WTI in triple digits, calendar 2027 and 2028 crude futures traded in/around the high $60’s for a good part of the summer.  That is changing as the longevity of this conflict seeps into the market’s awareness, as does the global oil/products inventory hole that gets deeper by the month.  Taking the over on 2027 was the right call.  Should we be thinking about the over on 2028 (which is currently trading ~$73.60/bbl)?

• Prices matter to demand.  When does “good” turn into “too good”?  Strong commodity prices are a function of the supply/demand/inventory balance.  We spend a lot of time evaluating supply impacts, while the demand impacts are usually more opaque.  In early September, Casey’s General Stores, a convenience store chain, reported earnings for the 3-month period ending July 2026.  Two things were noteworthy.  For the first time in almost two years, same-store gallons were lower y/y.  Additionally, in-store sales slowed.  When things cost more, there is a tendency for people to consume less.  We must watch this like a hawk as oil/gasoline/diesel prices remain high.

• China imports are ticking back up..slowly. From the January average of 11-12mmbopd, Chinese oil imports reacted to the war and high prices by falling to a June low around 6mmbopd (with parts of June as low as 5mmbopd).  Some of this was demand decline (perhaps 2mmbopd) and much was shifting consumption from imports to drawdowns of Chinese storage/inventory.  August and September imports have climbed by ~3mmbopd to ~9mmbopd, helping to firm up oil prices from summertime lows.  We expect go-forward Chinese imports to be somewhat price-dependent and gradually work their way back to 10mmbopd+.

• Multiple parts of the energy supply chain are blowing out.
  • Refining - With 5%+ of the diesel refining system offline (half in the Middle East, half in Russia), diesel prices are at record levels and refining margins are strong.  US refinery utilization is running well above seasonal levels as all maintenance that can be safely deferred is being deferred to capture sky high crack spreads.  With no incremental capacity available, high prices and demand destruction are the relief valves.  Expensive diesel will creep into the price of finished goods over the next few months from impacts across industries as varied as food/ag to over-the-road trucking.
  • Tankers - If you thought diesel prices were high, take a look at tankers! Rates have exploded from the combination of Middle East shuttling (which use more ships and have more waiting time), longer voyages as Middle East barrels are replaced/redirected and a price premium for Persian Gulf risk.  We’ve seen quotes of over $1MM/day (20x pre-conflict levels).  A VLCC carrying 2mmbbls for a 20-40 day trip is incurring $10-$20/bbl costs for a cargo worth $100/bbl.  Seems unsustainable…or another factor contributing to “higher for longer” for oil markets.

• The G7 authorizes an “additional” SPR release. A bit of gamesmanship in the late September announcement regarding the release of an incremental 100mmbbls of strategic stockpiles.  These barrels generally fit within the original IEA SPR release of 400mmbbls, but it was a chance for Germany, France and others to highlight they’ll be bringing 30-50mmbbls of diesel and products to the market by the end of the year.

• Russia to deliver “yuge” diesel volumes to global markets.  Flash over substance.  US President Trump shouted from the rooftops upon securing promises from Russia’s Putin to deliver up to 1.8 million tons of diesel to the US and global markets (300k tons now, 500k tons in November and 1MM tons “thereafter”).  Importantly, before getting too excited, convert this to barrels using 7.4 barrels per ton.  We’re talking 2.1mmbbls now, 3.7mmbbls in November and perhaps another 7.4mmbbls after that.  For context, diesel is a 30+mmbopd market where global exports are ~ 8mmbopd.  If Russia’s barrels ALL come before year end, it will be a global supply addition of ~2%.  Now we see why the tweets were in tons and not bbls/day.

• US export ban appears to be off the table.  For part of September, it looked like the Trump administration was going to implement a temporary export ban on US refined products.  There are many reasons why this is a bad idea, including starving global allies of much-needed product, disincentivizing investments by the US energy industry (producers through refiners) and setting a capital-spending-killing precedent of explicit market intervention.  Fortunately, the concept seems to have died, aided by the G7 announcement (discussed above) and intense pushback from the energy industry.  There should be less export ban risk following the US midterms, but future price spikes will inevitably resurface the issue.

• Venezuela getting a lot of attention.  In late August, it was announced that Venezuela would give 100-year concessions in 17 Venezuelan fields to North American Blue Energy Partners.  In turn, Blue Energy granted the US a 35% equity interest, the right to buy 20% of its production at a 20% discount to world prices and access to the remaining 80% of production. In theory, Blue Energy will now entice external/international capital to step in and help to quickly develop the fields.  A no-lose proposition for the US government (ownership and access to production), but probably a risky proposition for the external capital.  We continue to believe that Venezuela has very attractive prospects – we know the country once produced 3x more oil than it does today.  Converting prospectivity into return-producing projects will take time.  Wildcatters are striking deals today – some will make a killing, while others will be saddled with zeroes.  It is going to take TIME before Venezuela is a meaningful incremental oil producer.  Years not months or quarters.

US Industry Datapoints

• Scarcity value for “franchise assets”.  Pushed by activists, Devon recently divested its EagleFord position.  Analysts initially pegged the value of the assets at $3-$3.5B, but they sold for all cash at a tasty $4.2B.  Rumor has it that bidding was fierce and consisted of interest from public companies, as well as numerous private-equity backed portcos.  It has gotten notably more difficult to find sizeable asset packages and 10k+ virgin acreage blocks are non-existent.  If the private market (and foreign buyers) are willing to bid up assets, public markets will eventually follow.  Public companies are too cheap when there are food fights happening around existing A&D opportunities.

• Continued Upstream dealmaking.  After a war-driven pause in March-May, upstream activity has revived. We think consolidation is driven around a reasonable $70-$75/bbl price expectation.
  • Oh Canada! Canada heavy oil notched two multi-billion dollar transactions as Tamarack Valley and Headwater Exploration combined, as did Cenovus and Athabasca Oil Corp.
  • The international companies just keep coming.  Ever heard of Posco? Socar?  Danantara?   They’ve all bought US shale assets in the past few months.  Posco is the South Korean conglomerate that bought $550MM of non-op Marcellus assets from Chord Energy.  Socar is the state oil company of Azerbaijan that just invested $1.6B into Comstock’s Haynesville and midstream position.  Danantara is Indonesia’s new sovereign wealth fund that just did a $450MM recap with the Permian’s High Peak Energy.  These companies join Mitsubishi (acquired Aethon), Tokyo Gas (acquired Rockcliff), Ecopetrol (Oxy Permian jv), Jera (acquired GeoSouthern) and others in the push to own US assets.  In a world where hydrocarbon resources are more valuable and/or more difficult to obtain, US assets are “open for business”.  Expect more.

• Midstream kicking into high gear.  Midstream is a steady business that generates good returns, but usually not a lot of attention.  Recently, the sector has gotten significantly more active.  We attribute the activity to several factors.  First, midstream is catching up to the ongoing consolidation of the upstream energy sector – bigger customers favor bigger providers.  Second, infrastructure funds have raised huge amounts of capital and are looking to deploy it, even into the relatively unpopular traditional energy sector.  Finally, reasonably cheap valuations have been driven by generally disinterested investors.  Thus, if investors won’t step up and buy the companies/stocks, the companies are buying themselves (stock repurchases) and each other.  A few interesting midstream data points and transactions are highlighted below:
  • Solitude pipeline gets green light.  Another Permian gas egress project, with Whitewater Midstream, Diamondback, Devon and a few others planning for 4.5bcf of additional Permian takeaway in 2029/2030.
  • Targa and XOM sign 20-year deal. If you wonder about the duration of Permian gas production, don’t worry for the next 20+ years.  Exxon just committed to Targa for 20 years on newbuild gas processing plants that aggregate to ~800mmcf/day.
  • Apollo takes a $9B stake in OKE.  Does a PE-company inherently need to own public equity?  Never underestimate the level of complexity that financial players can go to deploy capital.  Apollo took a $9B stake in ONEOK (~$60B market cap) and promptly sliced up that stake into tranches that went into insurance products and other structured securities.
  • Chevron exits Hess Midstream.  Chevron stepped into Hess Midstream ownership and debt when they bought Hess (the corporate parent) last year.  In what must have been a massive headache and rat’s nest of a transaction, Chevron divested all ownership of Hess Midstream, handed over the debt and the Hess midstream general partner, re-cut Bakken gathering contracts, sold legacy Chevron DJ Basin infrastructure and received $200MM of cash. At least things are simpler now on both sides.
  • Good old fashioned M&A.  The music continues to play. In a $2.5B all-cash deal, Enbridge bought pipeline, storage and marketing assets across a number of basins from Tallgrass Energy, while Energy Transfer spent $2.6B to buy Delaware Basin pipeline and processing assets.

Energy Stocks

Energy stocks have overcome their wartime jitters.  Energy had a great start to the year prior to the conflict (XLE +25% through Feb), enjoyed a start-of-the-war pop (XLE +10% March), then tanked for the next three months as markets anticipated an end to the conflict during “deal is imminent” newsflow and the ceasefire and MOU (XLE -13% March - June).  Subsequently from the end of June through early October, the XLE has enjoyed another strong +25% on the growing realization of a long conflict and a lot of free cash flow.  Overall, YTD, energy via the XLE is +51% against the S&P500 +15% and Nasdaq +18%.

Thanks for the statistics, Pickering…but what comes next?  Well, it is sort of a scary market and not a dumb move to be treading more cautiously overall.  Interest rates are rising despite multi-pronged efforts by the US government to push them lower.  Real asset/commodity prices are making inflation worse.  Market breadth is shrinking, even as Wall Street strategists are raising S&P500 price objectives.  The fastest growing companies (almost exclusively tech) are raising capital spending targets every quarter and issuing debt and stock to finance it.  This is a scary cousin to behavior we saw during the shale boom (Wall Street embraced that also, by the way).  

We see little hope for a quick US/Iran resolution without an escalating war.  This means oil prices probably stay solid for the foreseeable future (although at ~$83/bbl, 2027 WTI is trading much closer to fair value).  That means energy stocks will continue to throw off significant free cash – always a good thing for stocks.  We haven’t seen even one crazy momentum run in the energy sector, which usually happens at least once a cycle.

We are eagle-eye watching to see if an $8-handle on 2027 WTI crude seduces energy companies to bump up capex and sidestep capital discipline.  It shouldn’t, but it might.  They shouldn’t, but they could.  While continued discipline is our base case, let’s listen to budget discussions as Q3 update calls begin over the next few weeks.

Net, net, net, net, net, net, net….the S&P may rip more to the upside, the S&P may struggle, but we are staying on the energy equity train.  The refining and tanker trades may keep working, but we don’t want to chase.  We’re happy to be fully invested in upstream and oilfield service companies with an occasional foray into midstream and power.  We are not wedded to any one outcome as we look into 2028.  We should and will remain data-dependent.

As always, we welcome your questions and comments.

(1) Bloomberg