During January, the S&P 500 gained +1.4% and the Nasdaq added +1.0%. The diversified energy sector soared +14.3% (S&P 1500 Energy, S15ENRS) with energy subsector performance as follows: Oilfield Services +22.3% (OIH), Upstream +11.1% (XOP), and Midstream +8.0% (AMZ). Clean energy gained +10.5% (ICLN). Front month WTI closed at approximately $62.20 per barrel, an increase of +13.6%. After topping out at nearly $7.50 per mmbtu during Winter Storm Fern, natural gas closed the month at approximately $4.35 per mmbtu (+18%).

COMMODITY MARKETS

As January progressed, oil market attention quickly shifted away from Venezuela. This isn’t inappropriate, considering there are few near-term supply and demand implications from Venezuela. However, it is yet another reminder that the market’s attention span is measured in days and weeks, not months and quarters (something Iranian protestors now understand firsthand).

From its lows in early January, WTI rallied from approximately $55 per barrel to as high as $66 per barrel as U.S./Iran tensions moved to the forefront. U.S. President Trump delivered a series of tweets in support of Iranian protestors, moved a carrier group into the Middle East, and issued additional commentary regarding nuclear talks. The odds of a conflict have clearly risen in recent days.

An oil rally is understandable when Middle East tensions arise. The tail risk of a supply-impacting confrontation could push oil prices into triple digits. However, two things must happen for a tail risk event to occur. First, there must be conflict. Second, there must be a supply disruption. The twelve-day conflict in June 2025 spiked oil prices by $10 per barrel but ended within a month with WTI lower than where it started because there was no supply disruption.

We do not believe the Trump administration has backed off its affordability agenda, with low oil prices as one of its centerpieces. Thus, we struggle to assign a high probability that the U.S. and its allies would take actions in Iran that risk supply disruption and an oil price spike. Tension: absolutely. Conflict: perhaps likely. Supply disruption: unlikely if history is any guide.

What is the current market implying? Assume oil trades at $100 per barrel if an Iran conflict emerges and escalates into supply disruption. Otherwise, assume oil trades in the $55 range where it was in early January. Today’s price is approximately $64 per barrel. For simplicity, assume the $9 difference between today and an uninfluenced price is entirely attributed to Iran risk.

The equation becomes:

$100 × (probability of Iran escalation) + $55 × (1 − probability) = $64

The implied probability of an escalation with supply disruption is approximately 20%.

If you are an Iran hawk, oil in the low $60s is too cheap. Oil will move higher if the situation escalates. But should investors fade a rally or buy a rally? Unless Iran is pushed into a corner with no way out but scorched earth, we suspect Middle East oil supply will generally remain uninterrupted. Thus, we are not rally buyers of oil.

On the fundamental front, increased U.S. pressure on Russia and Iran is having an impact. India has cut purchases of Russian crude, and there are over 100 million barrels of sanctioned Russian and Iranian oil currently “on the water.” We suspect much of this oil will wind up in Chinese storage, purchased at a substantial discount to world prices.

Oil bulls argue that Chinese strategic reserves are not commercial inventory. The oil may go into the country but may not come out quickly, instead being held for emergency use. Oil bears counter that supply exceeds demand, and once China stops absorbing excess barrels, prices could decline.

Meanwhile, OPEC+ is signaling it could boost quotas and production again in April, adding supply ahead of the typically strong summer season. Only a few countries are capable of meaningfully increasing supply, primarily Saudi Arabia, Kuwait, and the UAE. Recent reports highlight declining drilling activity in Russia, suggesting any meaningful production increase would likely require resolution with Ukraine and the lifting of sanctions.

Whether a production increase is simply signaling or an effort to appease the U.S. amid Iran tensions, our view is that the market is amply supplied.

Bottom line: oil markets are in limbo. Prices and fundamentals are weak enough that financial results are under pressure and the industry is nervous. Conversely, prices remain strong enough to discourage meaningful non-OPEC supply reductions or major cuts in U.S. shale capital spending.

Is the bottom in? Is there another shoe to drop? We suspect oil may need to test the low $50s to clear current oversupply, but forecasting price is extremely difficult. We remain convinced a tighter market lies ahead, where OPEC+ capacity is largely tapped out, U.S. shale maturity makes production growth more difficult, and demand continues to expand. Expect volatility between now and 2030.

CONSOLIDATION

It has been a strong start to the year for energy consolidation. The Haynesville continued its streak as a destination for Asian buyers, as Mitsubishi paid approximately $5 billion to acquire Aethon Energy. Aethon’s proximity to LNG markets and control of midstream assets were key catalysts for the long-rumored deal.

Haynesville-to-Asia deal value is approaching $10 billion when including JERA’s purchases (from Williams and GeoSouthern), Tokyo Gas acquisitions (from Chevron and Rockcliff), and Mitsui’s ongoing Western Haynesville drilling program.

On the oil-focused side, Devon (DVN) and Coterra (CTRA) announced a no-premium merger creating a $50 billion company. This places it among large-cap E&P peers including EOG (approximately $66 billion), Diamondback Energy (FANG, approximately $50 billion), and Occidental (OXY, $46 billion).

With its larger market cap and a year-long story of cost cutting and asset rationalization, Devon may receive increased investor attention. Notably, the resulting multi-basin, multi-commodity company was generally well received by Wall Street, signaling that companies do not need to be exclusively Permian-focused to remain investable.

Large-cap, pure-play Permian E&P Diamondback Energy retains the highest trading multiple in the sector at 6.3x 2026 EV/EBITDA, compared to the large-cap peer average of 5.4x (EOG 5.5x, OXY 5.6x, pro-forma DVN 5.2x).

In offshore drilling, Transocean (RIG) and Valaris (VAL) announced a merger that strengthens RIG’s position as the largest drilling company globally. RIG paid a premium of over 30% but emerges with an enhanced balance sheet and stronger positioning in premium markets.

Is consolidation finished? No. The benefits of scale and efficiency remain compelling at current valuations, particularly amid a challenging oil market outlook. Expect additional activity.

ENERGY STOCKS

Energy stocks have started 2026 strongly, outperforming the S&P 500 every week since December 26, delivering cumulative outperformance of approximately 2,500 basis points as of February 19.

Multiple factors contributed: discounted valuations assuming oil below $60 per barrel, a natural gas rally driven by winter weather, a broader commodity rally (gold, silver, and copper strength), and geopolitical risk premiums related to Iran.

However, we believe the most significant factor was rotation out of technology stocks. When roughly 30% of the S&P 500 experiences weakness (Nasdaq Composite down 6% from highs, software down 32% from highs), capital flows can meaningfully impact smaller sectors like energy.

The AI trade paused amid heavy capital spending and return-on-investment questions, familiar themes for anyone who lived through the shale boom. Investors also sold industries perceived as vulnerable to AI disruption, beginning with software.

Oil molecules cannot be synthetically created by a large language model. That makes energy a relative safe haven in the current environment. However, it also makes energy potentially vulnerable if investors rotate back into technology.

Energy has always been a noisy sector, driven by geopolitics, fundamentals, and capital flows. At the moment, the noise is louder than usual.

As always, we welcome your questions and comments.