Deteriorating.  March energy stock performance was solid given an ugly overall stock market.  The S&P500 fell -5.6%, the Nasdaq declined -8.1%, while Diversified Energy gained +3.6% (S&P 1500 Energy, S15ENRS).  Energy’s YTD performance of +8.6% made it the best group in the market so far in 2025 (against the S&P500 -4.3%).  March’s energy subsector performance as follows: Upstream +1.2% (XOP), Midstream +0.1% (AMZ), Oilfield Services -1.6% (OIH) and Clean Energy +2.8% (ICLN).  Oil gained a bit, adding +2.5% (~$71.50/bbl), while Henry Hub natural gas gained +7.4% to close at ~$4.15/mmbtu.⁽¹⁾

Our “February” writeup was extensive, capturing much of what happened during March including the surprise OPEC+ announcement to move ahead with returning barrels in early April.  This “March” writeup is going to focus on events that have occurred in early April, namely more OPEC+ barrels and the US tariff tantrum that has roiled global markets.  Bad things are happening, fear is high and sentiment is awful.

OVERVIEW

Unfortunately, the energy outlook continues to deteriorate.  US tariff announcements on April 2^nd were significantly higher than expected.  Fears of escalation, retaliation, inflation and an economic slowdown surged.  Adding insult to injury along the way, OPEC+ announced on April 3^rd (the morning after US tariffs) that it would accelerate the return of production in May – bringing on three monthly increments or 411kbbls/day instead of the planned ~140kbbls/day.  The market’s reaction was swift and dramatic.  WTI oil fell -6.6% (from ~$72/bbl to ~$67/bbl) on Thursday, April 3^rd.  When China retaliated with their own tariffs on Friday, April 4^th, oil took another $5/bbl dive (from ~$67/bbl to ~$62/bbl).  Stock markets were equally ugly, with the S&P falling -4.8% and -6.0% in two days.  The CBOE Volatility Index (VIX), commonly referred to as the “fear gauge” doubled (from 21.5 to 45.3).  Monday, April 7^th added to the pain, with oil briefly cracking below $60/bbl, before closing at ~$61/bbl.  The S&P took its 3^rd consecutive hit, falling -0.2% (and trading down over 4% intraday) and bringing the three-day shellacking to -10.7%.

From an energy perspective, since early March, we’ve had to worry about a supply problem due to returning OPEC+ barrels.  That supply problem is now worsening.  Additionally, demand problems have also entered the picture.  Short term in commodity markets, price is determined by sentiment and money flow.  Longer term, it is the fundamentals of supply, demand and inventory.  All those variables are currently negative, so we shouldn’t be surprised by lower prices.  The question now becomes…how low do we go? To examine this question, we must examine the players.

OPEC+

By the very nature of its actions, OPEC+ is signaling it is willing to take oil price pain to re-enter the market and recover volumes/market share.  OPEC+ isn’t a bunch of dummies. As the biggest OPEC+ producer and de facto leader of the cartel, we look to Saudi Arabia’s motivations for help in understanding.  Saudi knows this is a short-term revenue negative move.  The (very rough) math for Saudi is something like this:  February 2025 – 9mmbopd daily production x $70/bbl price = $630MM daily revenues.  April 2025 – maybe 9.1mmbopd daily production x $60/bbl price = ~$550MM daily revenues.  May/June 2025 – maybe 9.4mmbopd daily production x somewhere around $55/bbl = ~$520MM daily revenues.  If oil averages ~$55/bbl for the next year and Saudi produces an average of 9.5-10mmbopd, this move costs them between $30 and $40 billion.

This short-term self-inflicted wound would only be undertaken if Saudi felt there was long-term payback.  That payback could be in 1) better behavior by other OPEC+ players (Kazakhstan and Iraq get the most frequent mention), 2) overall market share (pushing non-OPEC and US shale to the sidelines) and/or 3) oil price.  OR it could also be in geopolitical tit-for-tat, delivering the Trump administration their desired lower oil prices in the short term in exchange for foreign policy benefits down the road.

Viewed with this lens, $30-$40B isn’t that much to pay for a US security guarantee or diminishment of Iran’s regional influence (to the benefit of Saudi’s clout).  With absolutely no evidence to support the claim, we are convinced there is a coordinated effort by Saudi to help the US try to offset tariff impacts.  A 3x acceleration announced the same day as US tariffs? Friends, that is not a coincidence. And if it spooks the Russians about their revenues, that’s lagniappe for the US.  And if it slows US shale activity somewhat, that is lagniappe for Saudi/OPEC+.

US SHALE

The US shale industry is in excellent financial shape, with balance sheets for most public players somewhere around 1-2x debt/EBITDA even when EBITDA is calculated at $50/bbl WTI.  Inventory has been replenished via consolidation.  The sector has been making good money at $70/bbl WTI and has delivered on its pledge to return capital to shareholders (debt paydown, dividends, share repurchase).  Thus, shale players will be hurt by softer prices, but not crippled.  A critical question will be whether companies decide to a) protect current production levels with maintenance level capex spending or b) allow production to fall in order to preserve free cash generation.  We have already heard anecdotes of US E&Ps taking steps to slow/defer activity.  This is with oiltrading in the $60’s for only a few days, albeit with terrible newsflow.

THE TRUMP ADMINISTRATION

Lower energy prices are a stated goal of the Administration, which accomplishes the dual agenda of 1) helping combat/offset US inflation pressures and 2) providing “beautiful, cheap, abundant American energy” as a global foreign policy tool.  Drill, Baby, Drill was having zero impact.  Behind-the-scenes horse trading with OPEC+ is having a big impact.  But Trump (or certainly Energy Secretary Chris Wright) understands that prices that are too low will quickly erode US production levels and the resolve of “friends” within OPEC+.  Thus, oil can’t be too bad for too long or both Administration goals will be at risk.  Needle-threading / game-playing at the highest level.

WHAT’S NEXT?

The current environment reminds us of speed chess.  Players make rapid moves, slamming their hands (or chess pieces) onto the clock loudly and dramatically at the end of their current turn.  Although the players have a strategy, observers often have no idea where the game is going.  Sounds about right.

• Iranian sanctions – This is THE single most significant potential “savior” of near-term oil prices.  The current setup is perfectly prepped for the US to turn off 500k-1mmbopd of Iranian exports via tougher sanctions.  OPEC+ barrels are already on their way.  Prices have fallen, so any rally would be to a manageable level (maybe low $70’s WTI).  However, if Iranian sanctions don’t happen, there is way too much oil on the market and a low $50’s price is likely.
• Russian oil buyer “secondary” sanctions – For a hot minute, oil markets got excited when the Trump administration threatened to impose incremental sanctions on buyers of Russian crude.  This seems to have fallen by the wayside in the midst of the broader tariff war.  Just like Iranian sanctions, the current setup would allow Russian sanctions to happen without risking an upside price blowout.  This is way down our bingo card for now.
• US government actions – Could the Trump administration soften on tariffs?  Could the Federal Reserve cut interest rates more aggressively than expected?  Either of those moves would generate a relief rally at a minimum and possibly an inflection point in sentiment.  There are a million permutations and we don’t profess to have any edge on any of them.
• US shale actions – This is not a 2014 repeat.  At $50/bbl WTI, PEP Research calculates that the 18 oily-focused public companies in its E&P coverage will generate aggregate free cash of ~$17.6B in 2025 and ~$13.3B in 2026.  Thirteen of eighteen companies have positive free cash and the five with negative free cash have negligible balance sheet risk through 2026.  However, we believe there is little appetite amongst the industry to be a hero and drill through a period of weak oil prices. Inventory is too valuable/scarce and investors are too adamant about capital discipline.  Therefore, we expect a watch, wait, and prepare for ugliness approach from US shale.  We expect producers to slow activity in the very near term (April/May), pushing drilling plans into 2H2025 and potentially DUC’ing wells while assessing the environment (DUC = Drilled-but-Uncompleted).  Any further deterioration ofoil price into the mid-$50’s (or lower) will accelerate reductions in activity/spending.  Q1 earnings in late April/May will provide concrete commentary into shale player thinking, but a lot could happen before then.
• OPEC+ actions – OPEC+ press releases have consistently mentioned that production increases may be paused or reversed subject to evolving market conditions.  Some duration of oil in the $50’s will make the cartel blink – it needs higher oil prices just as much as non-OPEC.  Perhaps, having delivered on “lower energy prices”, OPEC+ will have satisfied its side of whatever deal has been cut with the White House and will be focused on price again.  That timing will be measured in quarters, not months.

With more supply and potentially less demand, for the second time in as many months, we are taking down our expectation of average 2025 WTI oil price.  We started the year at $65-$75/bbl, cut to $60-$70/bbl last month and are now at $55-$65/bbl, still with more downside risk than upside potential.  Figuring out 2026+ is too hard at this point.  However, our mantra from previous downcycles remains intact – WTI in the $50’s doesn’t generate enough profitability for any of the players in the energy business, so prices can’t sustain at those levels for long.

ENERGY EQUITIES

The double whammy of even more OPEC+ supply and tariff/economy fears has gutted the energy sector in just a few days.  Without empirically checking, this feels like the fastest pullback we’ve ever seen, other than covid.  The benchmark S&P1500 Energy Index fell -7.8%, -8.9% and -0.9% in the three days following tariff announcements.  The -16.8% cumulative downtick compares to -15.4% for front month WTI, -10.7% for the S&P500 and -11.4% for the Nasdaq Composite.  Exxon has fallen -13.3%, Conoco -19.3%, Aramco -5.6% and higher beta subsectors of OFS and E&P are off -22.6% and -20.6% respectively.

Just because a stock or sector is down a lot doesn’t necessarily mean it is a bargain.  But energy is down a lot and it is cheap.  Currently, we believe oily Upstream E&P companies are discounting something around $55/bbl long-term pricing.  How do we get there?  At WTI $60 flat, most E&P names have 10-30% upside to their NAV (discounted future cash flows). At WTI $50 flat, E&P NAVs have an additional 10-30% downside.

Generally, buying energy equities when they discount oil in the $50’s is a smart thing to do – it is very good value.  However, value is not a catalyst.  And cheap stocks can always get cheaper when the newsflow is bad.  Finally, this energy rout is not happening in a vacuum - high profile stocks in other sectors are also “on sale”.  It is naive to think that cheap technology stocks (25%+ of the S&P) are lower on the shopping list than energy stocks (<4% of the S&P).

As such, it would be impulsive to argue that “the bottom is in” after a 3-day correction.  The VIX isn’t spiking because forecasting is straightforward.  We wouldn’t criticize traders for avoiding the entire energy sector until the dust settles.  Oil could crater into the $40s.  The stock market could fall another 20%.  Energy stocks could move from discounting $55/bbl to discounting $45-$50/bbl.  Conversely, any number of positive catalysts could emerge.  Right here, right now, we’re inclined to establish or add to energy positions (nibbling vs. gulping), with individual stock selection based on your specific risk tolerance.

Sadly, this is familiar territory.  The catalysts are always different, but the playbook is well established from the downturns of 1986, 1998, 2001, 2008, 2014 and 2020.  Fortunately, the world needs energy…a lot of it.  And as long as it does, there will be another energy upcycle somewhere on the horizon.   The longer the malaise, the more optimistic/aggressive/vocal we will become.  The deeper the oil price decline, the more enthusiastic and greedy we will become.  Stay buckled up.

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(1) Bloomberg