Rebound month.  The market turned up hard and energy followed.  The S&P500 rose +6.3%, the Nasdaq gained +9.6%, while Diversified Energy added +1.5% (S&P 1500 Energy, S15ENRS).  May’s energy subsector performance was as follows: Midstream +1.7% (AMZ), Upstream +8.0% (XOP), Oilfield Services +3.6% (OIH) and Clean Energy adding +7.6% (ICLN).  Front month WTI barely escaped from the $50s, closing +4.4% at ~$60.80/bbl.  Henry Hub traded sideways, closing the month +3.6% at ~$3.45/mmbtu.⁽¹⁾

ENERGY MACRO

Why do we almost always talk first about the energy macro in our commentary?  Because when the macro is good, it can overwhelm almost anything else.  And when the macro is bad, almost nothing else matters - individual company achievements have the tendency to be ignored and inexpensive valuation isn’t as cheap as it appears.

In the wonderful movie Thelma and Louise, the finale sees the heroes literally driving off a cliff, hands clasped and upraised in a signal of victory.  It appears OPEC+ is in the middle of a Thelma and Louise moment as the cartel pushes ahead with its return of production.  

OPEC+ monthly volume increases have been ~140kbopd (March announcement, April implementation) and three subsequent monthly announcements of ~410kbopd each.  The headline number of ~1.4mmbopd is less in reality as some of the “increase” is simply absorbing current overproduction by various countries, but we’re still talking about +/- 750k-1mmbopd of incremental, physical barrels.  With a stated goal of returning 2.2mmbopd, another 800kbopd OPEC+ barrels could hit the market by YE2025.  An oversupplied market headed for even worse oversupply.

Then we have the incremental geopolitical considerations of Iran and Russia.  Earlier this year, we thought there was a decent chance the Trump/OPEC+ production boost might be an opening gambit to be followed with stronger Iranian sanctions (and lower Iranian exports).  It now appears the situation could be going the other way.  Good for the world, bad for oil markets.  

Regarding Russia, the oil markets can now absorb tougher Russian sanctions without a resulting price spike into the $80s/bbl.  Will Russia come to the table on a Ukraine resolution?  If they do, oil markets will likely assume higher Russian production is an outcome.  We doubt there is much additional Russian supply if peace breaks out, but that won’t stop oil markets from being at least somewhat nervous/negative.

Net, net…the most likely outcome for oil markets over the next year is a slow-moving train wreck marked by rising global inventories and falling oil price. Boo!  Barring an appearance from animal spirits, we’re going to spend a non-trivial amount of time with WTI in the $50’s.  As such, in the meaningfully oversupplied oil world we foresee for the next 18 months, price-insensitive OPEC+ barrels will push price-sensitive, short-cycle shale barrels out of the market.  This means recent rigcount reductions and spending haircuts are just a start.  Price and activity are going to chase each other lower until US supply falls somewhere close to 1mmbopd (maybe more).  Stiff cocktail anyone?

We wouldn’t necessarily call it smooth sailing for natural gas, as there are always bumps, but there is a reason oil markets get five paragraphs in this writeup and natural gas gets one paragraph.  The multi-year natural gas outlook remains robust.  LNG demand will accelerate into 2026 and continue to grow year-over-year in 2027.  Data center-driven demand growth will be a fixture in the back part of the decade.  Silky cocktail anyone?

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INDUSTRY DYNAMICS

• As expected (and discussed above), the decline in commodity price and forward outlook is having an impact on E&P spending plans.  During Q1 conference calls, public Upstream companies outlined capital spending strategies ranging from “watch and wait” to immediate reductions in drilling and planned deferral of completions.
• Aggregating the results and guidance across PEP’s research coverage, the overall 2026 E&P capital spending forecast fell ~4%, but only resulted in a net 2026 oil production impact of -1% vs. prior expectations (a reduction of ~80kbbls/day).  Grossing this up to non-covered public companies and private operators extrapolates to a downtick of perhaps 200kbbls/day.  A pittance relative to what will eventually be required.
• On its earnings call, industry leader Diamondback Energy called out the peaking of US production after an impressive rise from ~5mmbopd to ~13mmbopd.  CEO Travis Stice said “Today’s prices, volatility and macroeconomic uncertainty have put this progress in jeopardy” and “..it is likely that U.S. onshore oil production has peaked and will begin to decline this quarter”.  We agree and disagree.  Oil production almost certainly moves lower from here given the confluence of oil price and macro issues. However, we believe shale still has plentiful drilling inventory at much higher prices.  If oil goes to $90/bbl in the next 3-5 years, we’d expect US production to claw back to record levels.  The US may be down, but it isn’t out.
• Power remains the hotspot of the energy sector.  During May, private equity was both a power seller and a power buyer, reflecting the feeding frenzy around being involved in the newbuild-constrained world of providing electricity. Utility NRG Energy spent $12B buying 18 gas-fired plants (~13 GW) from LSV Power.  Utility Vistra Energy paid $1.9B for seven gas-fired plants (~2.6 GW) from Lotus Infrastructure.  Finally, Blackstone Infrastructure and utility TXNM Energy entered into a ~$11.5B take-private transaction.  If the shale boom is any indicator, and AI doesn’t flounder, we’ll be seeing many, many more power deals over the next few years.
• The recent hiatus of oil and gas transactions ended during May.  Most significant was the ~$6B acquisition of Utica-focused private Encino by EOG Resources.  The advantage of EOG’s zero debt balance sheet is the flexibility to attack with an all-cash deal structure when an opportunity presents itself, even if the macro is squishy.  In West Texas, Apache sold Delaware Basin assets to Permian Resources for ~$600MM. In Canada, Strathcona Resources (symbol SCR CN) signaled a hostile, $4.3B bid for fellow heavy oil player MEG Energy (symbol MEG CN).  Given the macro, we expect fits-and-starts on the traditional energy M&A front, as buyers-and-sellers are intermittently comfortable and uncomfortable with the concept of “equilibrium”.

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ENERGY EQUITIES

Energy stocks rallied in May, following the broader market higher.  We do not sense any meaningful shift in institutional investor sentiment toward the sector.  It isn’t hated, but there is little love.  With the macro firmly in charge and generally unsupportive, we’ll be patient, focusing on alpha, not beta.

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(1) Bloomberg