FAQ On Traditional Energy Being in Bottoming Phase of 2+ Year Mini-Downcycle

Navigating The Energy Macro

Evidence continues to build that we are closer to the end of the 2-2.5 year downdraft following the oil price spike that occurred in the period after the February 2022 start of the Russia-Ukraine war. As a reminder, much of the Street was in “max bullish” mode in 2H2022 and early 2023 with numerous $100+ /bbl oil calls that ended up not materializing after the initial brief surge to $120/bbl at the start of the war. Some had even declared a new super-cycle had begun—a perspective we rejected via our “Super Vol, not super-cycle” framing. After two-plus years of gradual erosion in oil prices, we are now at the opposite end of the spectrum where most analysts are now calling for an “oil glut” and a crash to $50/bbl or lower. In our view, the “oil glut” narrative is as off base today as were the $100/bbl calls at the start of Russia-Ukraine.

Last week’s video podcast (here) went through two important views of ours: (1) that both oil prices and sector profitability were within shouting distance of what we consider a “normal” trough; and (2) the current gap between the sector’s earnings contribution versus its lower market capitalization contribution should close in favor of its earnings weight given our view that the sector is “under earning” currently.

In this week’s written post, we address major questions that have been raised regarding our view around why we believe the sector is nearing a trough, the risk of further supply increases that overwhelm demand (even if the latter is healthier than feared), and why we don’t believe narratives around hot-button topics like peak oil demand, “climate only” ESG, and narratives coming from major forecasting agencies are the primary source of underperformance or a discounted valuation. We use the popular Q&A format to address key questions.

Doesn’t profitability look like it’s around mid-cycle as opposed to trough?

Exhibit 1 shows real WTI (West Texas Intermediate) spot oil prices versus CROCI (cash return on gross capital invested), our preferred corporate profitability metric along with ROCE (return on capital employed). It is reasonable to look at the graph and observe that CROCI was meaningfully worse in 2016 and 2020 and ask why we don’t believe something closer to a 5%-6% CROCI would represent a true trough in profitability. Doesn’t the current circa 10% CROCI for the sector look more like a mid-cycle number?

In our view, it is important to look at sector CROCI in the context of the broader structural backdrop. As we have previously noted, major energy cycles are long-term in nature: 10-15 years up, 10-15 years down. We believe we are currently in year 5 of a new structural profitability upcycle that started in 2021 following the 2020 deep trough.

The 2016 trough came after an extended period of very high capital spending in response to the 2004-2014 “Super-Spike” super-cycle. The 2015 collapse in real WTI oil prices from over $100/bbl to the $50s/bbl was devastating to profitability for a sector that had become accustomed to a $100+/bbl oil world. Frankly, it wasn’t until the double deep trough bottom at the depths of COVID in 2020 that investors shouted “No mas. You must improve profitability!” What followed were major cost reduction and restructuring programs and companies without exception prioritizing free cash generation and capital returns to shareholders (i.e., dividends and stock buybacks) over production growth.

It is in that context that we find ourselves in 2025 believing that for both commodity price and corporate cost structure reasons, a deep 2020 (or 2016) type downturn is unlikely. On oil prices, we do not agree with the prevailing “oil glut” narrative that believes there will be (or is) anywhere from 2-4 million b/d of oil oversupply. We instead recognize a more modest oversupply on the order of 0.4-0.7 million b/d versus a starting point of near empty above-ground inventories and decreasing below ground holdings (i.e., diminished OPEC spare capacity). In Exhibit 1, the purple circle for 2025 CROCI we believe is better compared to the blue circles from 1998-2009 that represented mini-cycle pullbacks from that era.

Exhibit 1: Sector profitability approaching a near-term trough in the context of our outlook for this decade

Source: Bloomberg, FactSet, Veriten.

Exhibit 2 is a graph we have shown many times before. It shows Energy’s earnings contribution in the S&P 500 versus its market capitalization. My friend and former Goldman Sachs colleague David Kostin has a great line that “energy tends to punch its earnings weight in the S&P 500” meaning that over time the two lines will have a tendency to converge.

The yellow circles highlight select periods where the lines diverged. In the simplest sense, investors tend to look through periods where the sector is significantly over- or under-earning relative to mid-cycle. This can easily be seen in 2020 (under) and again in 2022 (over).

Currently, energy’s market capitalization weighting is around 3%, well below its 5% earnings contribution. However, as discussed above, we believe sector profitability is closer to a near-term trough—i.e., it is under-earning relative to the levels of profitability we expect over the course of the 2020s.

So what is the catalyst to change investor minds? It is most likely a clear recognition that there is no massive “oil glut” and that risk to oil prices and sector profitability is to the upside looking out over the next 1-3 years. We acknowledge that we likely still need to get through October “shoulder months” refinery run cuts and potential softness in crude oil prices.

Exhibit 2: We believe the discounted market capitalization weighting of Energy in the S&P 500 should close to the higher earnings contribution it provides

Source: Bloomberg, Veriten.

What do you make of all the cost cutting and rationalization announcements from so many oil companies?

In our view, the announcements from a range of oil companies of various cost cutting and EBITDA improvement initiatives is consistent with the idea that we are closer to the trough than the peak of the cycle. Cost cutting headlines are most likely to occur during periods of weakness, not strength. To the credit of industry, companies are not waiting around for a deep trough and are signaling that there is now a higher threshold for what is considered acceptable profitability.

We recognize cost cutting is not easy within companies and that such decisions are not made lightly or haphazardly. Layoffs in particular are never easy on corporate culture—something we are very familiar with from our time at Goldman Sachs where numerous cost structure adjustments were made during my 15 years at the firm. Looking back over just my 33-year career, energy industry employment is inherently boom/boost consistent with the profitability cycles. What is jumping out to us is that a sector CROCI of ~10% is sparking action that previously occurred at lower return thresholds. That bodes well for the sector’s future health and attractiveness.

Even if oil demand is closer to OPEC Research and OPEC+ output gains meaningfully lag the full quota unwind, there still is a non-trivial ramp in their production that will drive oversupply, no?

The biggest disconnect in oil markets right now is the higher starting point and growth rate OPEC Research assumes for overall liquids demand versus the IEA, the latter of which underpins the vast bulk of oil forecasts from leading consultants and Street analysts. We emphasize that it is not simply the higher growth rate in 2025 but the fact that OPEC also had higher liquids demand in 2024. Based on trends in observed inventories and commodity prices, we believe OPEC Research is much closer to the reality of today’s oil market than is the IEA.

We have said this many times before and we will repeat it again. We believe IEA viewpoints are made in good faith. It is up to individual analysts and companies to come up with their own views, whether they agree or not with the IEA. IEA data remains a valuable input into our own research process, as has been the case throughout our career.

Why the sudden support for OPEC, an organization you were skeptical of for most of your career until the past year or so?

We acknowledged in a recent video podcast that we have not always held a favorable view of “OPEC” as an organization. In the 2000s, we were skeptical of claims from leading countries that they held significant spare capacity (we think we were correct). In fact, during the 2000s super-cycle, we thought both OPEC and large oil companies did a masterful job of shifting public blame for high oil prices onto “Wall Street speculators” from themselves (none of which is accurate). My colleagues at the time Jeff Currie and David Greeley wrote a seminal piece debunking the idea that commodity investors or speculators were the reason oil prices rose so sharply; i.e., rising open interest in futures markets did not drive oil prices higher (the corollary we hold is also true; i.e., lower open interest does not drive oil prices lower).

During the height of the 2015-2019 US shale oil production boom, we had the great fortune of meeting the late Mohammad Barkindo, OPEC’s Secretary General from 2016-2022, who came to New York to better understand the shale revolution and Wall Street investors. It is through our affiliation with Columbia University’s Center on Global Energy Policy (CGEP) that we were able to meet with him a number of times in small group settings. We credit His Excellency with changing the orientation of OPEC to one of greater openness and engagement with a broader swath of oil market participants.

Mr. Barkindo’s successor, HE Haitham al-Ghais, has continued and in fact expanded on efforts to have OPEC engage more regularly and directly with oil market participants. We especially appreciate the clear and direct commentary from His Excellency, including on social media of all places (he is a great follow on Twitter/X), that pushes back on inaccurate “energy transition” narratives from other widely followed energy-oriented institutions. The world needs and benefits from a healthy and profitable oil and gas industry. We have typically reserved that comment for the western industry, but with this post expand the definition to include a trio of Middle East producers: Aramco, Abu Dhabi National Oil Company (ADNOC), and Kuwait Petroleum Corporation (KPC).

Exhibit 3: We recently ran into HE Haitham al-Ghais at the Oxford Energy Seminar, which we presented at the following morning

Source: Super-Spiked.

We have been concerned that the IEA’s move to “Net Zero by 2050” advocacy had seemingly spilled over to its shorter-term forecasts as well (we understand different groups within the IEA work on the different reports; the issue appears to be organizational wide). They have faced great pressure from left-leaning politicians and activists to declare oil demand will be peaking soon, despite significant evidence that points to continued oil demand growth for the foreseeable future. We do not believe anyone today can pinpoint the decade let alone year when oil demand will permanently peak—not when upwards of 7 billion people are consuming energy at levels well below The Lucky 1 Billion of Us. Simply put, OPEC Research’s analysis better aligns with our world view of energy’s natural hierarchy of needs. We believe this is reflected in OPEC’s short- and long-term forecasts, all of which have made us evolve our view of OPEC’s role in oil markets.

We also increasingly see scope for OPEC to be a better representative of developing world aspirations than the IEA, which was founded by rich, western countries in response to the Oil Crises of the 1970s. It is beyond the scope of Super-Spiked but well established that many high-profile, once great Western institutions are in need of reform. We see the potential for developing nations to turn to OPEC for their energy needs and to OPEC Research for analysis.

Isn’t the gap between Energy’s earnings weight in the S&P 500 and its market weight an indication that narratives like peak oil demand or “climate only” ESG are weighing on the sector?

Our issue with blaming say the IEA for “Net Zero by 2050” and peak oil demand advocacy is that it absolves sector analysts and management teams of their own willingness to vocally push back on those views. We started Super-Spikedand un-retired to Veriten in response to our disdain for mainstream energy transition narratives over 2021-2023. Essentially all large oil companies that publish outlook scenarios have a long-term oil demand view that is not appreciably different than the IEA’s stated policies scenario that called for a peak around 2030 and then a gradual decline thereafter; we consider this to be the IEA’s “base case” view (they don’t use that language to our knowledge). It is simply silly to think that oil companies showing scenarios of a demand peak slightly further into the 2030s followed by a long-term plateau is appreciably different from the IEA’s base-case; from an investor’s standpoint, there is little practical difference.

One major exception to the rule was the Bettering Human Lives report (here) published by the former CEO of Liberty Energy and our country’s current Energy Secretary Chris Wright. We would contrast his clear and unapologetic articulation of why the world uses energy and the role of energy sources like crude oil and natural gas versus the appeasement tone that we think characterizes so many of the ESG reports from companies across a broad range of sectors including energy. Besides Secretary Wright, there are a small handful of other oil and gas executives that clearly articulate the case for not only their company but also their sector (e.g., natural gas/LNG). We need more of that.

Why does any large or small oil company or for that matter any other oil market expert believe that they know with any certainty when oil demand will permanently peak? We have not seen even a single scenario that outlines energy sources and uses in a world where all 8 (soon to be 10) billion people on Earth enjoy rich-world lifestyles. How is that not what all people everywhere aspire to? Everyone on Earth deserves to be energy rich. Peak oil demand is one of the most ridiculous consensus views we are aware of. And it is likely contributing to the discounted market capitalization weighting of Energy in the S&P 500 relative to its earnings weighting. But the fault lies not with left-leaning ideologues espousing “climate crisis” narratives, but with so many within the sector that don’t forcefully lay out the case for why we use energy, including crude oil and natural gas, in the first place.

Bonus Questions and Clarifications

So you are declaring that the sector has reached bottom and are now pounding the table on traditional energy equities?

No, we are not saying that. Super-Spiked is not an investment newsletter and does not provide investment advice; we leave that to others on Wall Street.

Then what are you saying?

That the bulk of the 2+ year mini-downcycle has now occurred and that oil prices and energy equities are within shouting distance of a normal trough. The bottoming phase, which we would characterize as ongoing choppy trading, could last at least through the month of October at the short end and into the first part of 2026 at the longer end based on our base-case views that do not include a US or global recession.

Is that not investment advice?

No, it is not. At Super-Spiked and at Veriten our focus is on helping energy companies think through the long-term energy macro and policy outlook. Our focus is on where we are in the longer-term energy cycle and what companies should expect in terms of possible macro conditions along the way. This can be relevant to any number of conversations around capital allocation, M&A activity, long-term commodity price and margin outlooks, etc. We defer to the sell-side and buy-side investment community we were once part of for specific buy/hold/sell investment calls.

Why do you think so many oil and gas companies either stay quiet on the long-term outlook for their sector or engage in what feels like appeasement to the prevailing narratives espoused by politicians and global institutions?

That is a tricky one. Wall Street analysts and investors, including us, have long been critical of oil and gas companies that expressed a bullish commodity price view for fear of over-spending on projects or acquisitions that would yield disappointing profitability if the bull market didn’t materialize (and sometimes even when it did). We agree and in fact espouse the perspective of corporate planning incorporating a conservative commodity price deck. More specifically, we believe at a “normal” trough, a company should generate profitability no worse than its cost of capital (or just slightly below) and at a deep trough should never lose money. Practically speaking that means using a cautious commodity price deck for investments and M&A.

Got it. Then why call out larger oil companies for having long-term oil demand decks that are not dissimilar from IEA’s “base case” (our words) WEO view?

It is one thing to prudently assume and publicly declare a conservative commodity price deck for capital allocation purposes. It is an entirely different thing to project that at a time that only 1/8^th of the world’s population can be categorized as “rich” that oil demand is going to permanently flatten out within a decade and leave a majority of the other 7 billion people perpetually poor. Using energy, including crude oil and natural gas, “betters human lives.” Why is it so hard for more than just a small handful of CEOs to make that case loudly and clearly and without the language of appeasement that characterized so much of the 2020-2024 period? At a bare minimum, is it necessary to prominently highlight scenarios that de facto imply you are a sunset industry?

⚡️On A Personal Note: How Do You Know When Your Call Is Wrong?

I should really do this on video but let’s see if I can write it out. So you’ve made a call, maybe even a bold call as an analyst. It starts going against you. How do you know when you are wrong versus you simply need to wait out short-term trading noise? What do you do? I’ll give 2 examples from my Goldman analyst days. On the first we correctly stuck with the call; on the second we were wrong and very late to changing our view.

The first I’ll discuss was our Buy rating on Murphy Oil from the start of my Goldman career. This is a stock I upgraded on what turned out to be the day my first child was born in 2002. Putting aside the water-breaking drama and those moments between the upgrade on Goldman’s 4:10 call and her 7 pm birth, our thesis was that Murphy Oil was an inexpensive stock with an undervalued base business that had material upside from a very prospective exploration opportunity offshore Malaysia.

The first well turned out to be a dry hole. The stock goes down. We reiterate our Buy. The second well was also dry and the stock fell again. I can still remember calling Murphy Oil CEO Claiborne Deming, whom I did not know super well at the time, that evening and asking how he was feeling about Malaysia’s potential. He told me that they always thought about Malaysia as at least a 3 well opportunity and that they were hoping for a better outcome on the next well. He was calm, wasn’t defensive about the first two wells, and didn’t over hype the third well—all stylistic points that gave me comfort. I stuck with the call and pounded the table as a screaming Buy with an undervalued base business and material exploration upside. The third well, Kikeh #1, came in! This was my first big correct stock call as a relatively new and young Goldman analyst. I eventually came to be called Arjun Murphy by some in our salesforce for my close association and generally good stock calls on the company.

Key lessons learned: (1) our original thesis was sound: an inexpensive base business with material exploration upside; (2) if that third well had been dry, the call would have been wrong as it would have changed the call to simply “a really inexpensive base business” which was not the original thesis; a downgrade after a 3^rd dry hole would have been in order. The phone call with Claiborne has left a lasting impression on me. I don’t believe that third well had started drilling yet. Claiborne was calm and confident without being defensive about the dry holes or hyping the prospectively of the next well. I knew there was no guarantee of success, but thought risk/reward and confidence in management warranted sticking with the call with as much confidence as I could muster at that point of my career.

At the other end of the spectrum, I was bullish Petrobras coming out of the Great Financial Crisis. Petrobras, Suncor, and Hess were the horses we rode back up in 2009-2010. Unfortunately, I overstayed my welcome with Petrobras which was predicated on low-cost-of-supply oil production growth at a time of recovering oil prices—the super-cycle was back on track (or so we thought). But the Brazil government started changing the rules post 2010 from one of on the margin more free markets, competition, and capitalism toward one of nationalism, increased “social” spending from its oil champion, and maximum allowed rates of return on various spending. These were all classic red flags that government take, so to speak, was increasing for what was then and still is a state-owned oil company.

While I initially defended the maximum allowed rate of return by virtue of the fact that more of Brazil’s oil would be controlled by Petrobras, this was not a good conclusion and was not part of my original thesis. The new news did not make the outlook better; it made it worse and I foolishly tried to justify the change. A change for the worse in government take is a classic red flag in oil developments around the world, especially in a high oil price environment.

By 2010, my career was well advanced. I was a partner at Goldman, not a mid-level analyst at the start of my career like I was with the Murphy call. I was overconfident and argued my way through the change in thesis. You don’t have to be a veteran emerging markets analyst to appreciate the risk of government interference, especially in a country that had a long history of swinging back-and-forth from more socialism to slightly less socialism back to more socialism. I don’t quite remember specifically how I ended the Buy call, but am pretty sure I got bailed out of the embarrassment of a formal downgrade by a transfer of coverage to a new Brazil-based analyst we hired. To be clear, you have to take the pain of the downgrade to maintain credibility. There are no elegant, get-out-of-jail-free cards for an equity research analyst.

Lessons learned: (1) you can’t ignore thesis drift; (2) you have to take your medicine and not gutlessly wash your hands via a transfer of coverage to a new analyst you’ve hired; (3) as your career progresses, especially if it comes with material success, you become more immune to pushback and less fearful of being wrong. For equity analysts, that is a terrible place to be. It is the arrogance and sense of invincibility that comes from success.

On that last point, we can see that in some of our leading institutions today. We can see it in some of the loudest “energy transition” voices that are now talking “pragmatism” without apology or reconciliation with where their views were just a short while ago. It is how you lose credibility. I am lucky that getting an EM stock call wrong was not overly relevant to my Goldman or post Goldman career. But that doesn’t excuse how poorly I handled the change in hypothesis for my Petrobras Buy call. Somewhere in the midst of the Petrobras calling going south, deep down I knew my days as a Goldman analyst were numbered. I eventually retired in 2014 having lost the edge that had prior to that point driven my success as an equity research analyst.

⚖️ Disclaimer

I certify that these are my personal, strongly held views at the time of this post. My views are my own and not attributable to any affiliation, past or present. This is not an investment newsletter and there is no financial advice explicitly or implicitly provided here. My views can and will change in the future as warranted by updated analyses and developments. Some of my comments are made in jest for entertainment purposes; I sincerely mean no offense to anyone that takes issue.