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| Benchmark | MTD | QTD | YTD |
| S&P Composite 1500 Energy: | -5.0% | -12.9% | 20.5% |
| S&P Global Clean Energy: | -15.4% | 10.5% | 21.7% |
Energy Macro
During June, the US/Iran conflict moved from a cease fire phase to an MOU (Memorandum of Understanding) phase. This further step toward peace had stock markets rejoicing and oil markets tanking. Front-month WTI was ~$90/bbl on June 10th as MOU signals emerged from President Trump’s social media posts and Axios news reports. It was ~$81/bbl on Monday, June 15th following the Sunday signing of the MOU, it was ~$77/bbl going into the US Juneteenth holiday (June 19th) and is ~$70/bbl as June ends. This is despite intermittent flare-ups, drone strikes and missile launches.
Why has downside momentum clearly gripped oil markets? Below we list some reasons/catalysts. For the record, we don’t agree with them all, but it's always important to understand each side of an argument.
- The US appears unwilling to return to sustained kinetic actions against Iran. A pattern has been established - “don’t worry” commentary and weekend-only retaliatory action by the US. The goal seems to be to avoid spooking equity and oil markets, which has created the perception (and reality for now) that the worst is over in the Middle East and oil volumes through the Straits will trend higher.
- More supply IS moving through the Strait of Hormuz. Outbound and inbound tanker traffic IS trending higher. Oil markets don’t care what type of jawboning or one-off drone strikes are occurring, they care about incremental Middle East barrels reaching end markets….which is happening.
- China has not yet returned to importing crude. China was the big equalizer in the oil markets over the past few months. Rather than import high-priced crude, they shifted consumption to internal inventories to the tune of 5-6mmbopd. This kept oil prices from spiking even higher during the conflict. Some have equated China’s drop in imports to demand destruction. Until China returns as a buyer, short-term physical crude demand will be lackluster.
- The IEA is warning of a supply glut in 2027+. The IEA indicates supply will grow by ~8mmbopd in 2027, overwhelming demand. There is a lot of guesswork in the numbers, but if one assumes a conflict-induced reduction in supply of 10mmbopd for six months (March-August), this is an annualized 5mmbopd of the IEA’s “incremental” supply. Leaving 3mmbopd to come from other sources such as new/higher production from countries like Saudi, UAE, Iraq, Iran, Venezuela, Guyana, Brazil, US and Canada.
Our take? The world has gotten too pessimistic. FY27 WTI crude is trading at ~$67/bbl, -12% from recent highs and +10% from pre-conflict levels of ~$60/bbl. $75+/bbl feels like a more realistic number for the reasons we discuss below.
- This is the Honeymoon Phase. We are only two weeks into the 60-day MOU period. There is still plenty of time for US/Iran to get a deal figured out. Strait of Hormuz traffic is improving (despite drone attacks). China imports remain dramatically reduced. We can still assume that Middle East countries restart all their production quickly (because we don’t have any datapoints yet). Trump is attacking oil companies for gasoline price gouging. Financial short positions in crude are climbing. Oil price momentum is to the downside – reinforcing that everything is OK. Just like a marriage, it is impossible to predict when the Honeymoon Phase ends, BUT the physical side of the oil market remains tight…and eventually supply/demand/inventory dynamics drive the bus.
- Inventory rebuild isn’t a joke. It stands to reason that the 1B+ barrels that have been pulled out of global commercial and strategic inventories will eventually need to be replenished. It is unlikely the world will decide the global system can operate on 10-20% less inventory. If anything, the tenuous nature of the go-forward geopolitical relationships and increasingly isolationist policies argue for more inventory. China’s ability to pivot during the current crisis is a shining example of the value of supply optionality. As we move through the Honeymoon Phase (markets happy to just be able to access barrels) into the Reality Phase (how do we live going forward?), demand will be bolstered by inventory restocking. Assume 1-1.5B barrels added back to inventory by year end 2028 (call it 36 months to make the math simple). That is incremental demand of 1.1-1.6mmbopd. Undeniably supportive.
- China return to normal behavior. As oil prices spiked over the past few months, China dramatically downshifted its imports, relying instead on sizeable internal inventories. With short-term and intermediate term prices now down significantly, it stands to reason that China will return to importing again, rather than further deplete its inventory cushion. It’s balderdash to believe that China’s near/intermediate-term demand has structurally declined by any meaningful amount. Realized prices in China were not high enough for long enough to create structural demand destruction.
- Patience. While we believe crude fundamentals are inherently more bullish than the current futures curve, we acknowledge investor’s fatigue. In the short run, the conundrum is that investors won’t care until prices go up, but prices won’t go up until investors care. The next 2-3 months will bring plenty of datapoints to more definitively shape the bull/bear arguments.
Datapoints for Contemplation
- Data centers facing backlash. While AI remains the hottest topic on the planet, it is not all wine and roses. NIMBYism is showing up around data centers, with substantial pushback from communities that don’t want higher electricity and water bills and strains on their infrastructure. We suspect this resistance may result in some relocation of data centers and some timing delays, but the overall magnitude of the buildout will likely be unimpacted, unless/until investors apply the brakes.
- Pattern recognition anyone? During June, Google raised $80B in primary/new equity to fund its AI ambitions. Meta indicated it may raise new capital for the same purpose. These are some of the biggest companies in the world, they are highly cash generative and yet they are spending so much money they must go to the equity markets?! The energy cycle analogy is a scary one. Remember 2012-2014 when energy companies aggressively raised capital to drill more and accelerate production? Tech is different than energy, but some things are universal. AI is in tricky territory, which has energy investing implications. Even a small amount of slopover from a 35%-weighted tech correction could be meaningful money flow to the measly 3%-weighted energy sector.
- Energy stocks have roundtripped since the Iran conflict. The XLE energy ETF was $55.92/share on February 27th , the day before the Iran conflict started. It peaked at $62.56/share (+12%) on March 27th and closed on June 30th at $53.11/share (off -15% from the peak and -5% from pre-conflict levels). In the same time-period (Feb 27th through June 30th), the S&P500 is +9%. Ironically and painfully, you never really got paid for the fundamental tightening of the crude market. The market is saying the situation is a flash-in-the-pan. Voting machine vs. weighing machine. The voting machine is winning.
Last month, we talked about Apathy Before Clarity as it relates to energy markets. We also suggested several ways that clarity might be achieved. It is worth repeating those possible paths:
- Clarity might come in the form of a tech pullback that leaves investors with a willingness to evaluate other sectors and cash they are looking to redeploy, OR
- Clarity might come in the form of a resolution of the Middle East conflict and a non-war-influenced oil price. That likely $75-$85/bbl WTI oil price (our base case) and the associated energy company profitability will be harder to ignore, OR
- Clarity might come in the form of a rekindling of military activity and the realization we are not on a path toward resolution, OR
- Clarity might come in the form of a non-resolved conflict/ongoing ceasefire for so long that supply cushions are exhausted, oil inventories are pushed to operational minimums, and prices move to a demand-destroying level that can’t be ignored, OR
- Clarity might come in the form of us being flat-out wrong and the sector gets hit over the head with supply/demand imbalances (or some other situation) that make oil prices and current stock valuations unattractive
The movement of cease fire toward MOU has elevated the possibility of clarity via resolution. But we are far from out-of-the-woods and it is still too early to tell how this story ends. It’s hard to be patient, but that is what the situation requires.
(1) Bloomberg
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