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Can’t keep a bull market down! Middle East conflict didn’t faze the stock market as the S&P500 rose +5.1%, the Nasdaq gained +6.6%, while Diversified Energy added +5.0% (S&P 1500 Energy, S15ENRS). June’s energy subsector performance was as follows: Oilfield Services +6.3% (OIH), Upstream +5.8% (XOP), Midstream +2.6% (AMZ) and Clean Energy adding +4.6% (ICLN). Front month WTI rode a roller coaster, closing June +7.1% (~$65.00/bbl), having traded over $77/bbl intraday during Middle East hostilities. Henry Hub gained a penny during June, closing at ~$3.46/mmbtu.(1)
ENERGY MACRO
War came and went (at least for now) in the Middle East in the span of a few weeks. For the purposes of energy investors, the key takeaway from the “12 Day War” was that Middle East energy infrastructure was untouched…and therefore likely untouchable on a go-forward basis. Israel (and the US) did not damage Iranian energy assets. Iran did not damage Middle East energy assets. Iranian production and exports continued unabated.
Energy assets are arguably the biggest leverage point for both sides in the conflict. Iran receives a majority of its government revenue from oil exports. Israel could have easily decimated Iran’s production capability and financially hamstrung its enemy. Meanwhile, 20% of world oil supply moves through the Straits of Hormuz on Iran’s border. Iran could have easily disrupted tanker traffic and inflicted oil price pain on the Western world. But neither side crossed the line.
The Middle East conflict reinforced a lesson first highlighted in the Russia/Ukraine conflict. Affordable/low global oil/gasoline prices are more important than punishing bad guys. Iran’s biggest crude oil buyer is China. China doesn’t want $100+ oil. Israel’s biggest ally is the US. The US President has vocally hammered the concept of “low energy prices”. So, the bombs fall somewhere other than energy infrastructure and oil’s “risk premium” shrinks quickly.
From here, we turn our attention to two fronts – 1) will the Israel/Iran cease fire hold (with nuclear talks the nexus of the issue) and 2) will OPEC+ continue to bring incremental barrels back to an already-oversupplied market? We have no edge on the first topic, but suspect that even if hostilities were to resurface, the $10+/bbl spike experienced in June would not repeat.
Turning to OPEC+ behavior, on July 5th the cartel announced the return of another +550kbopd, targeted for early August. In a (reportedly) ten-minute meeting, OPEC+ delivered an upside volume surprise versus expectations of “only” another +411kbopd increase. Whether it is to punish OPEC+ cheaters, retake market share or deliver on a clandestine promise to Trump/US, there is no confusion about the direction of production. The baseline expectation now shifts to another meaningful August-for-September bump taking total returned barrels to (or above) the initially targeted +2.2mmbopd. Already, the market is beginning to speculate about another tranche of production increases beyond the +2.2mmbopd.
When trying to forecast, we certainly feel like throwing up our hands and taking a proverbial six month walk around the block to let the smoke clear. Thus, if oil were a stock, we’d say that sentiment around oil markets should soon be approaching “peak pessimism”. Unfortunately, oil is not a stock, it is a commodity where the actual physical barrels and supply/demand balance, not sentiment, play the deciding role on the commodity price. Our current thesis is that global inventories will build, but non-OPEC+ supply must eventually drop at least 500kbopd-1mmbopd to balance the market. The price required to force this non-OPEC+ supply drop (or a quick upward demand response) will be the price where crude finds a bottom. It won’t be $60’s WTI, it is probably $50’s WTI and it could conceivably be worse.
Why can’t things just linger in the $60’s? Because short-cycle US shale is, practically, the only near-term source of a supply decline. In the mid-$60’s, US shale producers will NOT proactively reduce activity (and therefore production with a relatively short lag). While not appetizing, the cash flow and drilling economics just aren’t bad enough to stop. We have seen this empirically in the US rigcount, where activity is down only ~13% in the past three months and remains 70% higher than the covid trough. Another example is Coterra (CTRA). With the macro hazy and oil in the $50’s, in May Coterra indicated a slowdown to seven rigs in the Permian. Recently, with oil prices in the $60’s, the company said it will continue to run nine rigs.
The only fundamental savior from the bearish outlook discussed above would be an OPEC+ head fake. Talking up production volumes without actually delivering the barrels. As the biggest OPEC+ producer, the country with the largest idled capacity and the most vocal driver of the current volume-increase strategy, Saudi Arabia is “the one to watch”. Bloomberg reports that Saudi’s June 2025 production was 9.4mmbopd, up from ~9mmbopd at the beginning of the year, but still well below the country’s 11.2mmbopd Sept 2022 levels. When Saudi volumes level off, a more bullish case could be warranted.
In this commentary, it’s the naughty kid that gets all the attention/ink. Natural gas? The outlook remains strong.
ENERGY EQUITIES
Energy is down to ~3% of the S&P500. Energy stocks discount long-term oil prices well below our view of midcycle/equilibrium levels (~$70/bbl WTI). And yet. But. Even though. Perhaps. Eventually. All the prior words precede any next sentence about energy stocks. We simply can’t get bulled up right now. We have our energy macro indicators for getting more aggressive on the sector (rigcount, oil price, OPEC+ production volumes, etc.). We also have our price levels for getting more aggressive on specific energy stocks (mostly near Liberation Day levels). When catalysts are lacking, you sit on your hands, search for alpha and be patient. Which is exactly our strategy right now.
As always, we welcome your questions and comments.
(1) Bloomberg
