Changing Dynamics in a Lagging Sector

The State of the Energy Market

Crude oil is kicking off the New Year in style with prices up 10% in the past month. Looking at the past year, crude began 2024 at $70/barrel, hit a high of ~$87/barrel at the beginning of April, a low of $65/barrel in September, and closed the year at $71/barrel. Energy stocks followed the price of crude for much of 2024 and gained just 1% on the year, underperforming the broader market by 23 percentage points.

Slowing oil demand from China over the last year has put a damper on prices. China’s crude oil imports dropped -1.9% in 2024, the first decline in three years, in part due to slower economic growth and broader electric vehicle adoption.^[1] Over the past decade, Chinese oil demand has accounted for more than 60% of the total global increase in demand, so flat demand from the region has played a major part in negatively affecting prices. But we expect part of the offset will be the strength from India as the  EIA projects that India will surpass China as the top source of global oil consumption in 2024 and 2025.^[2] India is one of our favorite long-term themes, as the country boasts the fastest growing economy in the world, one of the youngest demographics, and a pro-private business government. Improved oil demand from India will help negate less demand out of China, supporting prices.

Chart 1: India is Expected to Surpass China as the Top Oil Consuming Country^[3]

Crude prices are near 12-week highs due to a few factors, including the recent cold front across the U.S. and Europe, with natural gas prices up 18% over the last month as a result. But more importantly, it’s the incoming Trump administration policies that could impact the prices of oil in the medium to long term – although we are carefully watching the multiple dynamics. In the near term, countries appear to be planning ahead for what is likely to be a tougher enforcement of sanctions. Recently, concerns over sanctions resulting in tightened supply have translated into increased demand for Middle Eastern oil; February oil prices from Saudia Arabia to Asia rose for the first time in three months.^[4] During Trump’s first presidency, U.S. sanctions on Iran reduced Iran’s daily oil exports to below 350,000 barrels/day. Before the sanctions, Iran was exporting 2.5 million barrels/day.^[5] Over the last few months, Iran’s oil exports to China have dropped to below 1.3 million barrels, 550,000 fewer barrels than October, and Iran’s unsold floating oil reserves have doubled during this period. Iran is looking to plan for tougher pressure from the incoming U.S. administration on oil exports. 

Additionally, in their final days in office, the Biden administration is intensifying sanctions on Russian oil exports. The plan targets tankers transporting Russian crude and products priced above the $60 per barrel price cap placed on Russian oil. Similar to Iran, these sanctions are likely to be strictly enforced come the Trump administration’s inauguration on January 20. Broadly speaking, as long as demand remains unchanged, sanctions result in higher prices through less supply on the market.

Chart 2: Crude Prices Are Rising to Start the New Year^[6]

Most importantly, if the Trump administration is successful in reducing geopolitical tensions around the world and in convincing U.S. companies to produce more oil (three million additional barrels/day), there is a chance oil prices can retreat. But even at $50/barrel, U.S. producers are profiting as their break-evens are closer to $35/barrel.

That said, there will be more volatility in the sector this year, yet the valuations are quite cheap, free cash flows are strong (companies are deploying the cash to shareholders in the form of dividends and buybacks), and the sector is quite under-owned (especially relative to technology). We remain overweight the sector with bets in Schlumberger (SLB), Exxon Mobil (XOM), and Diamondback Energy (FANG). Other names we are involved in include ConocoPhillips (COP) and Chevron (CVX).

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Sources:

^[1] Source: Reuters. As of January 6, 2025.

^[2] Source: EIA. As of December 19, 2024.

^[3] Source: EIA. As of December 19, 2024.

^[4] Source: Reuters. As of January 7, 2025.

^[5] Source: Iran International. As of December 29, 2024.

^[6] Source: FactSet (chart). As of January 6, 2025.

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