Energy Macro

Enough already.  Every morning, afternoon and evening, we are bombarded with headlines regarding the latest gambit in the US/Iran conflict.  What is the latest Trump post on social media?  What is the latest commentary from Iran?  What “deal” is in the works?  We’ve paid attention because the market pays attention, but recently we’ve decided to step back and avoid the minutiae.

At a high level, where are we?

• This war started over Iranian nuclear capabilities, but is now focused on control of the Strait of Hormuz, oil prices and Iranian sovereignty.
• The US has clear military superiority, but has not eliminated Iran’s capability to inflict damage on Strait vessel traffic and Middle East neighbors.  
• Israel will continue to pressure the US to “finish the job”.
• Within Iran, hardliners are in control.  Continued conflict cements their leadership position.
• Iran perceives a US adversary that appears unwilling to step up militarily, wants a “deal” and has November midterm election pressures.
• Emboldened, Iran has moved the goalposts on negotiations around the Strait to levels that are equivalent to a complete victory for Iran if accepted by the US.
• Research from Thunder Said Energy indicates a war that isn’t won by decisive military victory lasts ~5.5 years on average (with the range between 3-8 years)
• Present, entrenched positions on both sides seem unlikely to be resolved by negotiation.
• Thus, either the US/Iran keep waging war via Tweet, one side “gives up” or we go back to fighting
• If loggerheaded negotiations take/waste time and kinetic action is postponed (or takes time to determine a victor), duration of the conflict is a logical outcome (with many historical precedents such as Vietnam, Afghanistan and Russia/Ukraine).
• Duration is a friend and enemy of both adversaries, therefore neither side has significant incentive to shorten duration -
  • US benefit: Time allows US sanctions to wear down Iran economically and delay/avoid further costly military actions
  • US benefit: Time allows US to replenish military supply chains and restock munitions
  • Iran benefit: Time tightens oil markets, pressuring price to the upside and hurting the US/world economically and the US politically
  • Iran benefit: Time allows Iran to rebuild damaged military supply chains and facilities and restock munitions
• Duration is a friend to short/medium/long-term oil prices as the oil markets fundamentally tighten every day as the world draws down inventories (strategic and commercial) at the pace of 5-10+mmbopd.
• Higher short/medium/long-term oil prices are a friend to energy profitability and (eventually/inevitably) a friend to absolute and relative performance of energy equities

Simplistically, our current thesis is an emboldened Iran that isn’t giving up without significant concessions.  This means the US can 1) wait Iran out, 2) tuck tail and walk away or 3) go back to bombing.  With this big picture base case, we don’t need to predict or react quickly to incremental datapoints/headlines from either side unless/until they change the fundamental premise.

For us, after dozens of headfakes, the rumor of a US/Iran “deal” or the threat of missiles/bombing isn’t enough to move the needle anymore.  Undoubtedly, the market will keep trading data tidbits.  We’ve resolved ourselves to this volatility, but hopefully staying above the fray will keep our head clearer and result in better analysis.

Finally, it is important to acknowledge that we’re trying to analyze a geopolitical iceberg where a majority of the action is taking place underneath the surface.  Thus, from an energy perspective, we are simply going to try and count barrels – the supply getting through the Strait, the supply getting around the Strait, the supply trapped behind the Strait, the supply being delivered outside the Middle East, the supply being delivered from strategic petroleum reserves, the supply decisions being made by importers like China (import vs pulling down on internal inventories), the demand implications of higher prices and the inventory levels that result.    

Counting barrels highlights three key issues.

• Middle East supply still constrained:  Currently, global oil supply is 6-9mmbopd below normal.  We get there by starting at ~20mmbopd moving pre-conflict through the Strait of Hormuz.  4mmbopd has been re-routed through the Red Sea, another 1-2mmbopd is being moved out via other pipelines and the Suez Canal and 5-8mmbopd is making it out of the Strait (depending on which sources you trust).  This says 11-14mmbopd of pre-conflict Middle East volumes are still making it to market, but much is still trapped.
• China imports ticking back up:  China throttled back imports dramatically as US/Iran conflict Round One ratcheted up and oil prices moved into triple digits.  In rough numbers, crude imports fell 6-7mmbopd by June, helping to offset the stress in the global oil markets.  There is much debate about how much of this decline in imports was due to Chinese demand destruction versus simply shifting consumption to (much cheaper) Chinese storage/inventory.  In the past month, Chinese imports appear to have increased by 1-2mmbopd and Chinese refiners are moving back toward pre-conflict levels of refined product exports.
• Global inventory drawdowns have limitations:  The global oil complex has shown impressive resiliency, leading some to think the March/April/May talk of shortages was fearmongering.  We disagree.  We estimate commercial and strategic inventories (including Chinese storage) have declined by 1.5+ billion barrels.  The market can’t keep pulling down inventories forever.  Sooner or later, the cupboard runs bare.  For example, in the US, the SPR has released ~115 million barrels and now stands just below 300 million barrels – which is in the ballpark of operational minimums at some of the storage facilities.  It will be a challenging Fall if the Strait of Hormuz remains contested.

We stick with our forecast that WTI should average at least $75+/bbl for the next few years.  FY2027 WTI futures now trade at ~$72/bbl, with FY2028 at $68/bbl.  The financial markets don’t seem to respect the tightening fundamentals, but we suspect they will as the remainder of the year plays out.  

US natural gas has become the forgotten commodity.  As 2025 ended, spot natty traded in the $4-$5/mmbtu neighborhood and calendar 2026 futures were around $4/mmbtu.  The world was full of promise from LNG export growth and future demand from data centers.  Today, spot natural gas is around $2.75/mmbtu, calendar 2026 trades for ~$3.10/mmbtu and calendar 2027 has fallen from $3.80/mmbtu to $3.30/mmbtu.  The global LNG macro has tightened with damage to Qatar export trains at Ras Laffan, forward month (European) TTF has doubled, but US gas languishes.

Why?  One word – supply.  Haynesville rigcount has moved up by 30% YTD, while Haynesville DUC inventory has declined.  Those are big wells and the basin will likely add 1-2bcf/day by year end.  Permian pipes are also to blame.  Since November 2025, the Permian has seen roughly 5bcf/day of new pipeline capacity via Matterhorn Express expansion (~500mmcf/day), Gulf Coast Express expansion (~600mmcf/day), Hugh Brinson (~1.5bcf/day) and Blackcomb (~2.5bcf/day). The additional takeaway has allowed Waha/Permian gas prices move from negative to positive, but is keeping a lid on Henry Hub.  We were more optimistic about gas at the beginning of the year – it certainly looked better than oil.  Now the tables have flipped, with the oil outlook materially improved and gas looking well supplied.

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‍Energy Industry

Q2 financial results for the energy industry were strong.  WTI oil prices averaged ~$96/bbl during the quarter and product prices were off the charts.  Exxon and Chevron reported combined Q2 earnings and free cash flow that were +2.5x higher y/y.  Investors yawned.  Since reporting on July 31^st, thru August 11^th, Exxon stock is +1.7% and Chevron stock is +2.0% against the S&P500 +3.5%.  While the majors have received limited love, the market is more entranced by the refiners, which have added ~800bps over the S&P500 since reporting blowout Q2 profitability in early August.  To the market, refined product tightness feels sustainable for the next few quarters due to the combination of inventory drawdowns and the war-induced Russian export halt.  Bottom line – big profits are good, but visibility matters.

Just like we’re becoming numb to the volatility of the US/Iran conflict, the industry is also starting to look through the noise.  During the past six weeks, we’ve seen a return to consolidation activity that was a hallmark of the past few years.  Williams announced the $5.5B purchase of Momentum Midstream (Haynesville), while the Middle East conflict didn’t stop a consortium of Blackstone, Brookfield and KKR from doing a $16B sale-leaseback on Kuwaiti pipelines.  In the Upstream sector, Magnolia Oil doled out $4.1B for EagleFord-focused Wildfire, while Matador spent $1.3B on Permian assets via Paloma.  Expand Energy continued to build out its gas marketing capabilities with a $1.3B acquisition of Twin Eagle Holdings.

Texas has ~90GW of peak power demand (July 2026) being supplied by ~150GW of installed total capacity.  Big numbers…but dwarfed by the ~475GW of interconnection requests that had been submitted to ERCOT and PUCT (Public Utilities Commission of Texas).  This overwhelming demand is the result of relatively cheap “spots in the line” for interconnection to the grid, theoretically quicker approval timing than other power regions and the attractive environment for data center development in Texas - lots of land, cheap and available natural gas fuel, favorable regulatory environment, etc.  The Texas governor surprised the industry in early August with an emergency freeze on approvals and a project-by-project audit on connection requests.  Sounds like an ominous roadblock, but depending on how it is implemented, this could actually improve the system by sweeping out the line-squatters and marginal, low probability projects and providing a faster track for “real” projects.  We’ll be watching this closely.

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Energy Investing

Usually, stocks in a cyclical sector must climb a wall of worry – worry about a commodity, worry about earnings, worry about the length of the cycle, worry about capacity additions, etc.  Energy has the usual cyclical wall of worry to climb, but also has to climb a wall of apathy.  At 3.3% of the S&P500, there are five individual companies that each have a bigger weighting than the entire energy sector.  Nvidia 8%, Apple 6.9%, Google 5.7%, Microsoft 5.6% and Amazon 4.0%.  Technology overall is an ~38% weighting in the S&P500 – 10x more than energy.

How can energy garner attention when headlines read “Nvidia Taps Wall Street for $500 Billion Funding Commitment”?  The world’s biggest company getting some of the world’s biggest financial players to commit the most money ever announced.  Sheesh.

As such, with ongoing geopolitical volatility and commodity price volatility, we can hardly blame investors who look at the energy sector and say “I don’t have the time to figure this out” or “I’ll focus on energy after the conflict concludes and there is more certainty”.  And many are saying exactly that.  We think they are missing an opportunity, but the opportunity cost is small.  A diversified investor that puts a market-weight 3.3% of their portfolio in Exxon and doesn’t think about it for a year will not make/break their performance.  In the time it takes to analyze and create a differentiated energy portfolio, the investor can search for alpha in the tech sector where the absolute/relative performance benefits are more tangible.

The above argues that the real moment of opportunity for energy stocks will come when a) the US/Iran conflict definitively resolves, b) when investors are forced to look for other ideas due to a slump in technology or c) when energy dynamics are so compelling that investors must pay attention (probably due to an upward move in commodity prices that is viewed as structural rather than temporary).  None of these conditions currently exist..but all could be lurking around the corner.

Even though most of the market isn’t paying much attention, we still feel there is excellent value in the energy sector.  Assuming $75 WTI oil in 2027, independent oil producers are trading between 2.5x-5x EBITDA.  Free cash yields are 8-25%, providing a lot of ammunition for cash return to shareholders or ammunition for M&A.  We’ve said consistently, if investors won’t buy energy companies, the energy companies will buy themselves or each other.  This isn’t wishful thinking; they’ve been doing this for the past several years.  We’ve also said consistently that with the current fundamental setup, we are enthusiastic dip buyers, while refusing to be rally sellers.  The time to take money off the table is 50% higher, not here.    

We’ll close this commentary with one additional observation of the energy sector.  This market is more herd-driven than ever before.  Squeezing through a door that is only the width of 3.3% of the S&P500 is hard to do when all the heavyweights are moving at once.  I’d rather be on the inside, welcoming the herd to buy into my energy positions up +10%, +20%, +30%, than be on the outside lined up with everyone else.    

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(1) Bloomberg