Alright alright.

Ladies and gentlemen we have a deal!

Greatest meal deal ever. It’s like a Tacos Supreme Combo.

3 luscious Taco Supremes plus an ‘Murica sized big gulp of sugary carbonated water to help all that medicine go down. Mary Poppins couldn’t be prouder.

Eventually . . . and inevitably, we figured he’d cave. He had to. He had no leverage. He literally backed the USS Boxer, and its Marine Expeditionary Unit, away from Asia a few weeks ago, which was a pretty big signal that he didn’t have the stomach to escalate the situation. In turn, Iran had to translate its military leverage into a diplomatic one, and it has. Could it or should it have waited until the markets dislocated, and the global economy came to a grinding halt? Debatable. Moreover, Iran has to be suffering economically as well since their oil flows have plummeted because of the US oil blockade. Regardless, I for one am glad they didn’t. So instead, they relented a bit and signed (or will sign, or will sign shortly after Trump’s birthday tomorrow) a Memorandum of Understanding (“MOU”).

The MOU has six general points:

1. Lifts the blockades on the Strait of Hormuz (“SoH”) within 30 days. Iran will clear the mines, and not collect tolls, whereas the US will remove its blockade. Iran has claimed it will charge service fees to facilitate transit so that outcome is still in the air. We think that’s likely. They’ll get something, but something that’s palatably worded for the world. Facilitation fee, support fee, or security fee, something. It’s all about optics.

2. Iran commits to never pursuing a nuclear weapon. It will agree to either a 15 or 20 year halt to uranium enrichment and dismantling of its nuclear sites. The parties will negotiate the technical details of the monitoring over the next 60 days. Most likely, they’ll end up in a state where they keep the uranium on their soil from which they can enrich the uranium in small concealable batches (as if inspectors will prevent them from developing a nuclear weapon, which they’re infinitely more motivated to obtain).

3. Hostilities against all Iranian proxies (Hezbollah, Houthis, etc.) will cease. Israel has claimed it’s not part of the MOU, but we think the US has enough sway over Israel that even if there are violations here, they’ll be small and both parties (Iran and the US have incentives to overlook it).

4. Missile program - Iran will keep this. Don’t expect much movement here.

5. Compensation - Iran has asked for $270B in reparations for war damages, and the US will likely grant the release of $24B held in banks worldwide. They’ll release those funds as conditions are met, but expect a “sign on bonus” for Iran. They’ve asked for it, and they’ll get it.

6. Sanctions - oil and gas sanctions on Iran will be lifted immediately. So Iran should be able to start recovering economically.

So framed another way. This is a 60 day ceasefire that reopens the SoH for 60 days while the parties sit and negotiate the specifics of the nuclear deal. Don’t read that as a threat or chance that we’ll go back to war.

President Trump has shown zero appetite for that, and wants to immediately restore the SoH.

Most likely, the US will end this entire endeavor with an IRGC in a strengthened position. It’ll get sanctions lifted, billions in cash, retain its missile program, and exercise de facto control over the SoH. As sanctions lift, they’ll rearm, refortify, and upgrade their weapons package. I fear that’s the longer-term scenario. This is an emboldened and empowered entity, and the US an unfortunately embarrassed one. Iranian drones and ballistic missiles have shown that the emperor has no clothes, and with that, it’s stripped the US of its cloak of perceived military invincibility. The lesson that quantity has a quality of its own has been retaught, and that a continuous barrage of cheap munitions can economically and strategically hobble your foes.

Impacts on Oil

Putting on our investor hat though, what this allows us to do is to reframe the oil trade. What the administration has orchestrated in the past few months has been nothing short of phenomenal. It’s kept energy prices rangebound and arguably under control as it’s weaponized the volatility of the paper markets. We’ve known all along that the paper market is >30x the size of the physical one, and in the short-run that can push physical price indicators aside. Trump’s team has successfully eviscerated investors’ appetite/ability to take bullish positions in the front of the curve. Given the volatility that each tweet engenders, holding positions became untenable. In fact, the risk/reward eventually favored shorting the oil market, and that’s what investors did.

Combine bottomed out sentiment . . .

With high short-positioning . . .

. . . and eventually once the headlines flipped to a favorable peace deal, the bottom softened for oil prices.

So $80-85/barrel it is for now.

Lower Chinese imports coupled with reduced demand has mitigated the otherwise enormous 14-15M bpd supply loss. As of now, it appears that the collective voluntary measures have reduced visible global draws in Q2 to ~5-6M bpd (note the key word “visible”).

We think it’s higher as some of that is really due to seasonality, and China’s reduced imports and lower refinery runs means it likely drawn down product stocks. Still, price doesn’t lie, the price on the screen says $85/barrel, even if we think visible and less visible inventories have drawn.

So what’s next?

What’s next is the recovery.

How fast and when?

For takeaway capacity, it’s a no brainer. The Middle East (Iraq, Saudi Arabia, UAE, etc.), will quickly and furiously build/expand their alternative pipelines. Iran has proven it can weaponize the SoH at any time, so export capacity needs to be increased. UAE should be set by 2027, and the Saudis undoubtedly soon after. Will the upgraded pipelines like Yanbu and Fujairah be under threat? Sure, but they’re arguably easier to repair than prying open a strait under enemy fire.

As for supply recovery, we have to assume that it’ll take about 2 months. That’s the time needed for ships to exit the Gulf, unload, and return. Only by returning can tanker ships then drain onshore storage and allow producers to restart production.

The ships currently trapped in the Persian Gulf will leave first, transferring around 100M barrels that are sitting in floating storage to hungry Asian/European customers. That immediate shot of adrenaline should help keep prices steady as we get through this busy/high demand summer season. On the flip side, demand should also recover as energy prices climb down from their highs, and summer burn increases to counteract the heat that begins in earnest. We’ll still have a net shortage, but if China maintains its posture on reduced imports, we can muddle through. Call it a visible draw of 3M bpd draw over the next 60 days. By September, we should be ~80% recovered on supplies. Thereafter, near or full recovery by year end. We think that’s a decently conservative estimate, and largely what the energy agencies and Goldman Sachs thinks.

This does mean oil will continue to draw in the coming months. Largely because of the lag effect of sailing times/production restart/disruption, seasonality, and uncertainty as we muddle our way through this MOU. Fair value for oil is nearer $90-95/barrel right now (below is only looking at commercial stocks), and will nudge higher in the next few months as we recover.

The path thereafter depends on production recovery vs. demand growth.

Will there be lasting impacts to the prolonged shut-ins (we doubt it), will the SoH navigation return to pre-war levels (we also doubt that), will producers ramp production much higher in an $80-85/barrel oil environment (yes, but muted), what will the geopolitical premium be going forward (who knows), and what type of strategic petroleum reserve restocking/build will we see (definitely incremental demand)?

All of these things are still uncertain, but we’ll start modeling them as we move forward. It is safe to say that in the past 3.5 months, we’ve managed to materially drain our inventory reserves and commercial stocks, strengthen a Middle Easter foe to a previously unfathomable position, and severely degrade our perceived ability to project power and backstop/defend alias in a volatile regions.

While we’ve managed to temper oil prices in the short-run, the knock-on impacts will almost certainly reveal themselves as we emerge from the fog-of-war. Shell’s CEO has stated that we’ve globally lost ~1.2B barrels of oil in the past few months, and we think that’s about right. We’re approaching tank bottoms these days, and though we’ve managed to pull-back from the global brink with help from Chinese reserves and a minor reduction in demand, we’re going to get tight if they don’t continue with their largesse. As oil prices drift lower here in the coming days, they’ll find a floor. Once the dust settles, and short positioning clears out, don’t be surprised to see prices drift higher as we keep drawing into the summer. We still expect prices to average ~$90/barrel for the rest of the year, and we should have a better view into 2027 as we get into Q3. Suffice it to say, energy companies are still pricing in $70-75/barrel. So those should receive another uplift.

As we’ve done throughout this whole exercise, we’ve kept repeating the phrase “we shall see.” Just when you think something is set to happen, another entirely unexpected situation unfolds. In January it was $55-60/barrel for years to come . . . and then the market gave us triple digits. Low prices have created pervasive apathy towards energy security, and it’s bred overconfidence that we can seek regime change for a major producer without destabilizing energy prices. Well we found out. Turn the page, and we’ve decided to suppress oil prices for the greater good as inventories draw. Yet meanwhile, we expect producers to refill our emptied tanks even when the economic incentives to do so are uncertain? Hmm, the producers appear to be as skeptical as we are.

2026 is the year the US lost a war in the Middle East, and we don’t think that means energy prices will be, or should be cheaper going forward, nor do we think suppressing oil prices and introducing volatility in the oil market will lead to producers running flat out as we come out of this mess.

Again “we shall see” . . . in the meantime, enjoy your tacos on your birthday Mr. President.

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For those who don’t know, the San Antonio Spurs are battling it out with the New York Knicks for the NBA championship, and after come from behind win on Wednesday night, New York leads the 7 game series 1-0.

The next game is today. The Knicks won their last championship in 1973, so the droughts been long and dry. Led by their floor general Jalen Brunson, the gritty Knicks have a real shot against Victor Wembanyama and friends.

The timing though couldn’t have been more fortuitous as the parent company, MSGS, has just filed a Form 10 a few weeks back to being exploring the spinoff. As you may remember from our last article, MSGS actually owns two professional sports franchises, the aforementioned New York Knicks in the NBA (basketball) and the New York Rangers in the NHL (hockey). It also owns a few minor league teams, but the real value of the company lies in the NBA and NHL franchises.

Given the recent selling prices of other comparable large market NBA and NHL teams, we conservatively projected the fair market value of MSGS at $11B, and we were too conservative on that. Let’s shoot our shot.

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Nothing major, just a minor fender bender. Stopped in the middle of a parking lot, waiting for a young lady to back out. She backed out, then kept backing . . . then backing . . . then . . . oh this is gonna be close . . . and

Bonk.

Doh. Oh well. It’s minor, no one’s hurt, stuff happens. A few scratches and dents, let’s trade insurance info.

She said sorry, and I said no worries, everyone’s fine.

Insurance adjuster calls and says . . . she said she was stopped after backing up and you drove into her.

Which then made me question my recollection. Was I really not stopped? Was I moving? Fortunately, my son who was with me in the car started laughing after I told him.

So I think this is what the kids call “gaslighting” these days. It’s a term that comes from the eponymous play Gas Light, where a manipulative husband slowly dims the gaslights in their home, but continuously lies to his wife, insisting that she’s imagining the creeping darkness.

It’s something we seem to be doing much of these days. Served so casually and frequently, sprinkled with a dash of deception. Problems are never anyone’s fault, it’s yours. You’re overly sensitive. Your analysis is wrong. Your judgment? Way off.

My facts are right, and I’m living the truth. You? You’re confused at best, and delusionally wrong at worst.

Really? Is this really how life works today? Because for a split-second even I’m doubting myself. Was I really not stopped, even though I was the one honking, knowing that she was about to hit me? Did I really just decide to whimsically truck someone in a parking lot? Why’d I do such a thing . . . wait, but did I?

The Jedi mind trick is REAL I tell ya, and none of us are even Jedis.

Yet that seems to be my life these days. One where my real life mirrors my investment reality, because guess what?

The Strait of Hormuz (“SoH”)?

Yeah . . . apparently that doesn’t matter either.

We actually don’t need 15% of our world’s energy supplies. You can cut it off and nothing misses a beat. We don’t need buffers, we don’t need healthy inventory levels, and we don’t need a material supply response. We’re Just Fine.

Once a peace deal is signed, everything will be awesome. Scratch that, right now? EVERYTHING IS AWESOME!

Why wouldn’t it be?

$87/barrel . . . WTI

$91/barrel . . . Brent

That’s the price of oil today. Makes sense. Frankly there is no shortage, at least not one that’s visible in prices. There’s no real shortage because none of this matters. We’re losing only 8-9M bpd. Sure it’s much more than that, but Strategic Petroleum Reserves help paper over 2M of the losses, demand destruction another 2M bpd, and voila, we have “only” an 8-9M bpd loss. A loss, mind you, that will quickly disappear soon when peace breaks out.

Soon meaning, whenever the US/Iran finally agree to reopen the SoH. To be honest, this seems likely. Eventually both sides will need to reopen. Iran to solidify diplomatically the military gains its made on the battlefield, and for the US, a detente so it can put this entire folly of an excursion to bed.

The non-stop jawboning and messaging from both sides means nobody can really stomach the trade. You can’t take a position in the prompt when the volatility and unpredictability works against you. As you bounce from headline to headline, you financially bleed from the thousand of knicks and tweets. Hence oil prices not only tread water, but start to sink even though the SoH remains closed. Besides, any CTA program worth its “momo” will tell you a flat to down line pales in comparison to this lunar moonshot of a line.

People go where the momo goes, and the momentum has achieved orbit. Whether that’ll be around the moon or Mars, it’s still to be determined, but it’s sure better than this . . .

So there you have it. One unconstrained and another forced into a predetermined channel. A tale of two charts. Not just that, but a tale of two narratives.

The Tidal Wave

Surely once the SoH reopens, the oil will flow. Not just flow, but it’ll be a tidal wave of supplies. First, OPEC and OPEC+ will surely ramp right, I mean they have been since they were removing all the quotas right before the war began, right? Well yes, but that actually didn’t result in any higher production.

Other than seasonality (i.e., increasing production/exports in the fall/winter), the above chart seems pretty flat doesn’t it?

Okay, then what about Venezuela and a few of the underpeformers, they’ll pump right? Didn’t we “take over” (oh sorry “free”) Venezuela to ramp its oil production? Other than a minor bump, there hasn’t been much change. Maybe the experts were right, maybe boosting the country’s production will require material capital investments, which’ll take awhile.

Hmm. Okay then the US . . . they’ll react, right? That’s the quickest and most price sensitive barrel. Drilling is about to go through the roof . . .

Oh yeah, now we’re talking! Look at that blip! 3 months into this. Up. Yet, despite that, we’re down YOY in rigs, frac spreads, and rigs in the prolific Permian basin?

Go figure.

It’s amazing really because what’s happening is that the SoH closure stemming from the conflict is inducing only a few suppliers to produce some incremental supplies. Sure oil is up from $60/barrel to $86/barrel, nearly 40% more, but really there’s been no step change in drilling.

The administration has done such a successful job in numbing oil prices, that the analgesic’s worked on the supply side. In other words, by suppressing the potential price spike, they’ve also neutered the supply response. What producer would willingly overproduce if the prices are so uncertain? Sure, on the fringe, you’ll get some supply response, but on the whole? Not much. The anemic response we’re seeing stems directly from the uncertainty they’ve created.

So then ripple that logic even further. If it’s not responding at these higher prices, what the likelihood production increases when peace arrives and you try to jawbone it lower even more? Exactly . . . nada.

Nonetheless that’s not what the narrative currently screams. Once the SoH reopens, supplies will increase. Increasing supplies mean recovering inventories, and that means lower energy prices going forward. In turn, that’ll create deflationary pressures, allowing the Fed and other central banks to lower rates, benefitting stocks.

Again, all of that’s predicated on supplies returning. Not just returning, but returning to their peak, and then some, and recouping the 1.5 billion barrels that were, or will be lost. The excess will also quickly refill all our coffers.

Really? 1.5B? Look you can quibble with that figure. Maybe not as much production was lost, maybe it was more, or will be more . . . or less. What matters really is the directionality.

The market is expecting that. Despite removing 20% of the world’s supplies and consuming 20% of the world’s inventories, will we quickly revert back to the lower prices we’ve had at the beginning of the year? Call us extremely skeptical.

Unfortunately for us, that’s the expectation and it’s ALREADY PRICED INTO THE MARKET as oil has already started its drift lower with the impending peace treaty/cease fire/negotiation to negotiate that’s coming soon.

The stock market is at an all-time high, and the bond market has stabilized. If either steps out of line, then expect another jawbone. We’re already into June now and Trump’s in “no rush” to negotiate. Well publicly at least.

We don’t think that’s anywhere near true as reports of his various and constant overtures are most likely true. What we do know is that inventories continue to drain, producers have been non responsive, and once the SoH reopens, production is even more likely to wallow further if prices decline. Who’s going to refill our inventories? Collectively? No one.

In fact, there’s a greater chance that we’ll have lost some production with the prolonged shut-in. Regardless, jawbone away. Keep telling us those lies. Keep telling us the room’s getting darker, and that we’re most assuredly wrong.

We’ll just sit here and hope that they’ll stop shortly, otherwise it’s really lights out for everyone.

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Okay, let’s talk oil. $96/barrel right now after what’s news reports that an agreement to defuse the current standoff is within reach between Iran and the US. Though there still are issues, particularly around what’s in and what’s out of the initial agreement, there seems to be some progress being made, or at least a concerted effort to do so.

Is this really a 30 day extension of the current ceasefire, or is this a transitory step to something more . . . permanent? It’s unclear.

What is likely happening is the framing of the issues, and the cadence of the steps each party will take as we walk through these next few weeks. Call it a trust exercise, or heck call it “trauma bonding,” if you want, but whatever it is this will take time. Particularly when both parties are saying “you go first.”

Really though the Iranian’s are feeling flush at this stage. It has the leverage in both time, geography, and political will. The US does have two weapons though: a military hammer and a really large bullhorn. Frankly, it’s using the latter to great effectiveness as oil pries have milled around in a very specific Goldilocks range.

Thanks to US jawboning, the price has stayed fairly rangebound between $90 and $110/barrel. The increased volatility stemming from an outlandish tweet at anytime of day, amplified by certain media members, means traders simply can’t hold long positions with any conviction. Not only will their systems automatically flag the vol, but the value at risk also jumps. What ends up happening is the capital gets skittish.

With traders vacating their traditional role, we’re left with the physical market to tighten and tell us what the true price of a barrel of energy should really be. What’s surprising to us is how well the physical market has hung in there for the past month. While inventories are falling, a buyer’s strike from refiners is occurring. There’s little reason to buy if the pundits, the President, and analysts are all predicting a quick resolution to the conflict. Though they’ve been doing so for the past few months, one of them will be right one day, and the longer this drags on the more likely that happens.

The zeitgeist is almost certainly that oil prices will fall quickly in such an event, and from a risk/reward standpoint, let’s play it out and wait. Draw inventories and reduce run rates, and pray for a speedy resolution. Why bid on high dollar barrels if you can stay patient? Sure product stocks will draw if refiners don’t produce, but that’s the consequences of picking your poison.

Everyday is a Draw

We’re 2/3rds of the way into May, and the overall deficit is approaching 9M bpd as visible oil inventories start to truly reflect the supply outage.

Compare that to the same chart last week, and already we can see May figures have increased from 7M bpd.

Lag-Effects

It’s the lagging impact of this entire venture. Once Asian stocks depleted, the pull on Western inventories have picked up materially. Supplies disrupted in March and April are only starting to show up in the other visible parts of the world (i.e., Europe / US). Storage information/data in these regions/countries is less opaque, and the March and April outages are beginning to show given the lagging impact of how oil moves through the system. It’s lagging both in terms of how it shows up in the data and in timing. As Western crude/products start getting pulled in large amounts, land stocks will draw, but oil-on-water (“OOW”) will increase as the barrels are exported. Once they land, OOW will decline, and land stocks will rise, only to finally fall when the barrels are refined/consumed. Eventually though, it will all fall, OOW will settle, whereas land stocks will decline. It has to unless China decides to just step-in and plug any gaps with its vast SPR (doubtful).

From a timing perspective, we further anticipate this will continue into late summer, as March’s SoH outages “show themselves” in the figures for April, and April’s SoH outages show in May, and so on and so forth. We can already see the impacts in April’s data as inventories of both US crude and products have started falling counter seasonally.

It’s clear from the charts above that product stocks here will get spicy. We typically build inventories now and into the summer for consumption in the fall/winter season, but this year, we’re seeing a counter-trend, which means there won’t be as much available by October. Product prices are likely to stay elevated into year-end, which means refineries will run flat out. Commercial crude inventories are doing much better though since releases from the US SPR have been so hefty. That portion won’t stop for awhile. Net/net, commercial crude stocks will still draw despite the SPR release and for many months as seasonality coupled with global export demand pulls barrels away. WTI and Brent pricing will need to close that gap for barrels to remain in the US, but they’ve yet to do so.

Zooming out a bit, our real-time OECD tracker also shows the bleed down. With little to no evidence of demand destruction (particularly in the better insulated and wealthier countries (i.e., filled with high energy consumers)), the draws will keep occurring until supplies improve.

In total, global onshore storage though is falling, and will continue for the coming weeks. Here’s Eric Nuttall from Ninepoint.

Though not as steep as he initially projected, we think the draws will still be about the right amount in quantum, if not pace. If no one’s cutting back materially in their habits, then the draws are inevitable.

Drawing Now, and Drawing Later

So what happens in the coming weeks, will matter for inventory balances at the end-of-summer. Thereafter, remember, there’s still the matter of “normalizing” the SoH. Most analysts estimate it will take another 1.5 months to reorient the tankers as many have been sitting idle or re-tasked to other routes. Producers will need to drain on-shore inventories before they can restart the field, and they can only do so if the tankers start loading inventories. So even on a conservative basis, pencil in another 200-300M barrels lost as the ships traverse and reform their congo lines. We’re likely well into July before we start to see the first barrels reappear in Asia if things get sorted out . . . today.

It’s unlikely though because the current ceasefire draft between the US/IR means negotiations will begin after Hajj. The sacred Muslim pilgrimage to Mecca starts this Sunday and ends sometime next Friday, which means we’re into June already before the parties really sit down and grind through the specifics. If we’re being optimistic, we’re looking at a resolution likely in mid-June.

Even that’s a bit fanciful because can Iran and US resolve the open issues of uranium enrichment and the SoH in two weeks? We doubt that. The nuclear issue has been going on for nearly a decade, and the SoH has finally been weaponized. What’s the likelihood Iran enters these negotiations on its high horse and flexes its muscle? Yeah . . . high.

It makes sense though. They are “winning,” and the longer IR draws out negotiations, the more leverage it gains as global inventories really start to drain during the high demand summer season. We’re a bit surprised that the SoH has been closed this long, and at this stage, it’s really a wait-and-see approach we’re taking. Every week of closure means another +60M barrels lost. More if you count non-visible inventory draws and China’s SPR releases (some of which is come from underground stores). We still have 10-12M bpd of shut-ins and that’s really the missing key. March, April and May . . . and now likely June. Another month or two of this, and the impacts will directly impact Q4, and effectively all of 2026.

In turn, this will drive full year free cash flows (“FCF”) for E&Ps so high that they will materially deleverage, and/or drive significant shareholder returns (i.e., buybacks). Many companies will likely increase dividends by redirecting the newly freed-up cash used to previously pay higher interest expense, and by systematically shrinking their share counts. Companies could also issue one-time dividends, but again, they’re more likely to repurchase stock to permanently bake-in the benefits stemming from all this uncertainty. Every day is another dollar, and as this continues, it’ll only expose how cheap the shares of energy companies are, and how much of a folly this entire exercise has been.

June, here we come.

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“It didn’t look that bad” . . . that’s what I texted to a buddy. Transocean’s (“RIG”) earnings that is. Not sure why it’s down 8% the day earnings were released this week.

Keep reading the filings though . . . ah there it is, a second Form 8K, which says . . .

Anti-trust. A “second request” from the Department of Justice (“DOJ”). I guess you can’t effectively oligopolize a sector and not expect at least some deeper analysis from the DOJ. Fair enough.

We knew this would be coming, but how do we walk through the analysis? How do we discount the risk of the US denying RIG’s ability to close the Valaris (“VAL”) acquisition?

Well let’s take a look.

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Occidental Petroleum (“OXY”) reported Q1 2026 earnings this week, and for readers, we’ve long argued that it’s one of the most underpriced stocks in the E&P space.

To be fair, this was a mixed quarter. It was great in the sense the company executed and delivered what it promised. It was terrific because the company outperformed in certain areas. Unfortunately, it was also terrible because the management team blundered into a costly derivative, but maybe, just maybe, there’ll be salvation. Let’s get into it.

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Onto Week 10.

12M bpd of disrupted Hormuz flow in April, and this will likely continue into May as diplomacy looks to be a ways away with uranium enrichment and the Strait of Hormuz (“SoH”) reopening intertwined. It’s difficult to sort out since one provides the leverage for another.

1. If the US relents and ends its Iranian blockade, that emboldens the Iranians. Similarly, if the Iranians end their SoH blockade that would also dramatically reduce their leverage at the negotiating table.

2. Uranium enrichment and nuclear development. Will the US be willing to separate this? The US, and the Trump administration specifically, needs a “tougher” deal than the JCPOA that he exited from. Otherwise, how could he paint this as a victory? In contrast, the Iranians smell weakness. The longer the SoH remains blocked, the more leverage it has to not only take control of the SoH long-term, but also retain its nuclear development program. The SoH becomes “the nuke” to be negotiated for, and the “actual nukes” take a secondary position.

3. Will the Iranians be willing to cede nuclear development for 10, 15, 20 years to allow Trump to declare victory? That’s doubtful as the current strategy is working well. Though the blockade has dropped Iranian exports to a measly 500K bpd, and the country is suffering economically, history has proven that they can weather an extended storm (i.e., see prior sanctions with Trump and COVID).

4. Ballistic missile development? No word on this of late. Too complicated given the core issues above, which means Iran gets to keep it.

So effectively we’re left with a stalemate on the panoply of issues, and that stalemate means we bleed.

Bleeding 12M bpd that is, that’s the deficit. That’s the amount of crude and products that’s not flowing because of the war.

Right off the bat we’re already starting to see demand destruction. Prices at $100/bbl oil aren’t so high that they should already kill demand, but it’s happening because of the actual absence of molecules. There just isn’t any supply for some frontier Asian countries. Hence demand is down. Middle East demand is also obviously down, and not hard to see why when missiles and drones fly.

So reduce that 12M bpd by 3M bpd of demand loss, and we should see somewhere in the neighborhood of 9-10M bpd of inventory draws. Well are we?

Thus far, we’re only seeing around 7M bpd.

In total, visible inventories appear to be falling about 6-7M bpd. This includes about 3M bpd of SPR release.

To reiterate, the above is “visible” inventories. What’s tougher to track though is non-visible, non-OECD products inventory and we think that’s the difference. Once that bleeds down, then visible inventories should draw slightly higher, or further demand destruction in non-OECD countries will occur. Non-OECD countries include China, India, Brazil, Argentina and Russia, so these are material in every sense.

Though the charts above are from JP Morgan, if we take a peek at Goldman Sachs’ chart, we can see similar findings.

Goldman though pegs demand destruction at 2.5M bpd vs. JP Morgan’s 3.5M bpd, so split the difference at around 3M bpd, but whatever the demand destruction we settle on for now, the thrust of the argument is about the same. We’re currently drawing around 6-7M bpd of visible stock, and some other portion that we can’t see.

Unlike COVID, this energy crisis will have a delayed impact. Whereas COVID saw immediate demand destruction, supplies didn’t immediately stop, so inventories ballooned. The Iranian conflict has the opposite impact as oil-on-water still flowed for a few weeks as the last ships arrived at their destination. Those supplies have finally tapered off, so the air pocket has firmly arrived at the far flung ports.

For the foreseeable future, we’ll see visible inventories fall further as consumers/refiners pull on all available stores. In turn, prices will rise to further curtail demand as the bidding war progresses and the stalemate continues.

Oil analysts had predicted the sequence to move from East to West. So has the first to draw was Asian inventories? Yup.

Next up, Europe, and finally, the farthest barrels in the West (US) will bear the final brunt . . . or so we thought.

Well guess what?

Brunt? Meet backside.

It’s just getting started, and we’ll see the visible side fully reflect this crisis.

US crude/product stocks are the most visible inventories to track. The Energy Information Administration (“EIA”) provides timely and comprehensive data, and for the week of April 24th, it reported a nearly 23M draw on inventories. If you’ve any doubt, this is a precipitous fall during the “slow season,” one where we typically try to build inventories for the summer high demand season. Products (i.e., gasoline, diesel, jet fuel) are drawing the fastest.

Crude draws are starting as well. Below are two graphs (a crude chart excluding SPR inventories (i.e., US commercial crude stock), and a second crude chart including SPR (i.e., total US crude stock). Commercial inventories are being supported by US SPR releases, but despite this, commercial crude inventories are still falling (i.e., the SPR release helps mitigate not eliminate the inventory declines).

We’re expecting further fireworks in the weeks to come, especially as May starts to kick-off the higher demand summer season. Just take a guess as to what prices will do then. Again, remember, even if the SoH were to reopen today, we’ll have another 2 months of logistics sorting itself out, so another 2 months of draws.

For the time being we’re at a stalemate. While the US and its allies can continue to manipulate the paper market to suppress the prices of oil, the inventory shortage will inevitably translate to price. (Say what you will about Zerohedge, but this is very likely to be true given the movement in oil prices yesterday with little headlines).

What’s an investor to do? Well, despite the above, we think Eric Nuttall’s tweet about crude inventories is ultimately the most fitting.

Barrels are draining and barrels will continue to drain as the stalemate continues. Every additional day the SoH remains closed, means Iran gains further leverage in any negotiation. In truth though, it effectively needs to hold out for one more month (here’s a Financial Times piece on the timeline).

It’s why we think the next step will likely be another US attack on Iran. What can’t be achieved at the negotiating table will have to be gained on the war table. The US has little leverage here other than blustering and bellowing for Iran to capitulate, but Trump’s desire for a deal is so intense and the potential impact to the global economy so unfathomable that Iran knows the longer it waits, the better the deal.

Unfortunately, a win for Iran is a loss for Trump, and hence, the chasm between their positions can’t be easily bridged unless one of them loses another chess piece. The clock favors the Iranians, and they know it.

As the weeks pass, something has to give, and Iran won’t unless kinetic action forces it to. After which, the table will be overturned, and everyone will pick up the pieces to see where things stand in the sand.

Tick tock. Tick tock.

Week 10 here we come.

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That’s Goldman’s estimate of production shut-ins for the Middle East. We had pegged it around 11-12M bpd, so a smidge higher we suppose.

Our original assumption was that the US/Iran War would end on April 21, the day the ceasefire ended. We wrote that to be conservative, with diplomats winging their way back and forth to Islamabad, there was a chance some sort of agreement could come to fruition. Hence it was safer to assume that a miraculous agreement could be crafted to resolve the seemingly intractable issues between the US and Iran (i.e., the Strait of Hormuz (“SoH”) closure and Iran’s nuclear enrichment program).

The deadline passed uneventfully though. This week saw the ceasefire extended indefinitely and the resignation of Iran’s Head of Parliament Mohammad Bagher Ghalibaf from the negotiations team. News reports soon surfaced that Iran’s Supreme Leader Mojtaba Khamenei had reprimanded the Iranian negotiation team for the first round of discussions because they had placed the topic of nuclear enrichment on the table. Whatever the reason, the IRGC and the Ayatollah appear to be in firmer control, which should mean harder line positions prevail. So off we go, finishing up a 7th week of this campaign. We’ve likely lost ~700M barrels of oil as of April 21st, and now that it’s apparent negotiations may take more time, we’re in bonus time. Like soccer though, we’ve little clues how long the bonus time will last.

The US’ blockade of Iran’s blockade is an attempt to apply more economic pressure, but since Iran largely sells its oil to China, those vessels have been unmolested. There’s little reason for the US to anger the Chinese, especially as their own meeting is scheduled for early May. So if a majority of Iran’s oil continues to flow, we do wonder, when is a blockade not really a blockade?

A Day of Delay, Keeps Lower Prices Away

The question does remain though, how long do the combatants have to survive this? The US believes it has effectively as much time as it needs, and certainly more than Iran. The idea is that Iran’s storage will eventually hit tank tops and in a few weeks, they’ll be forced to shut down wells. In contrast, Iran sees the global economy and postulates that the higher oil prices go, and the lower the stock market moves, the weaker the US’ resolve in furthering this war. It’s obvious the US wants to TACO and that a ground offensive is unpalatable militarily, strategically, and politically. Despite the headwinds, the stock market has rallied massively in the past 19 days. Moreover, oil prices have remained below $100/barrel even as the physical market indicates tightness. In fact, the administration is actually quite pleased with the current state of events, as it gives them the perception of leverage in the ongoing negotiations. Whether it really does or not is questionable.

On Saturday, the US is sending Steve Witkoff and Jared Kushner to Islamabad to engage with the Iranians. Takes about 16 hours to get there, so figure they’ll start chatting Monday. What’s telling is that the US didn’t send Vice President JD Vance, who led the delegation last time. We think this speaks volumes, as there’s still a chasm between the two sides. Frankly, we’re not entirely sure they can bridge it, but the Iranians will be going as well, though the two are not meeting directly.

The US will certainly not give up control on the SoH to the Iranians, and accept a permanent tolling system. Granting such a concession would be viewed as a strategic loss and anger the Saudis/GCC coalition. It could also impact the sanctity of the petrodollar, as the GCC would view the US as unreliable allies.

Furthermore, the US is seeking an agreement that’s tougher than the JCPOA for nuclear enrichment, but can Iran actually swallow such a bitter pill? We don’t think so. We don’t think so because Iran actually thinks it’s winning militarily (note: they are). Not in the conventional sense, but from the strategic one. They still control the SoH even with a devastated air force and navy. Drones and mines are sufficient these days, and Iran has been effective in employing them.

The paper market and the stock market have been entirely dismissive of the supply outage. No thanks in part to the jawboning that’s created extreme volatility and higher margin requirements, which then dampen the risk appetite of traders. So oil languishes below $100/barrel, and it gives the generalists betting on technology, semiconductors, and AI, that all is well, and all will be well . . . because just look at the stock prices, we’re making money.

If so, then neither side has felt enough pain yet to force a compromise. Instead of malleability, we’re looking at recalcitrance and a prolonged period of negotiations.

So Monday it is . . . for the next round. April 27th. 6 days after April 21st. Multiply that by 14.5M bpd and we’ve just lost another ~87M barrels. For every week the SoH remains closed we’re looking at 100M barrels of crude never produced. That figure’s permanent, and it is real. Now the real drawdown in inventories will be less because of demand destruction (we think around 4M bpd) coupled with SPR drawdowns (3M bpd) will soften the impact, but SPR drawdowns are inventory reductions, just in a different pocket than commercial stocks. In the end, both pockets are on the same pants, and them pants sure be getting tighter.

In Totality

We’ve seen the tally anywhere between 700-900M bpd lost (not including the 200M bpd likely to be lost when the SoH starts to reopen because tankers are mispositioned and production restarts need to ramp). We’re also not factoring in any complications to restarting oil fields that have been laid dormant for a month, or refineries and infrastructure that need to be repaired.

This is fine.

This is fine right? No . . . fine is furthest from the truth. Asia’s cupboard is threadbare, and Europe is running dry. As US inventories drain in the coming weeks (because of the export demand as everyone pulls barrels away), prices will creep higher. Those that have not will buy from those who have, eventually pricing out the other have nots.

The US, the last location to drain given its distance from the Middle East has begun to see increasing draws. Product exports have recently hit an all time high.

Crude is following, as the weeklies have started moving.

In totality, our contemporaneous OECD tracker is starting to show the divergence overall (US/Europe/Japan/Fujairah).

Remember the above includes Japan, and Japan has stopped reporting product changes, but we can guarantee it’s down by tens of millions.

Inevitably, unless massive demand destruction kicks in, our global choice is between losing a historic amount of inventories . . . or unfathomable amount.

The first green dot is already set though. We’re in late April, so visible inventories will almost certainly fall to the indicated level. It’s shy of the 1B or more we think will be drawn from inventories because the above chart doesn’t fully capture the harder to see product stores. Again the safer assumption is 1B barrels lost as of now (inclusive of a 2 month ramp-up that sees the world lose 200M barrels), and every week thereafter another 100M barrels.

So at this juncture it’s really how much further do we bleed inventories down.

As the weeks play out and visible inventories start draining hard, we’ve little doubt that oil prices will recapture their highs on the front-end. Once the back-end of the curve starts to move, the E&P equities will also find a new floor. Contrary to commentators out there, we still think energy matters.

Molecules will rule over paper. While the paper market can hang on every Presidential tweet and distort what’s happening because volatility prevents market participants from seeking real price equilibrium, inevitably a stock-out will force the issue.

The haves will outbid the have nots, and you can take ours . . . for a rich price.

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(Link Below)

Open Square Capital Quarterly Letter (Q1 2026)

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That’s where we’re at. Sure the price of oil is well above $100/barrel today, but it’s $70/barrel at the back-end.

It’s a reflection of what’s become of the market all these years. One where energy holdings cratered to about 3% of the overall value, more than halving from 2022, and multiples more from earlier before.

It’s what happens when you spend most of 2010-2014 lighting shareholder’s capital on fire under the pretense of chasing growth. Forget profits, and the market inevitably forgets you. It is the weighing machine after all, and this sector has been found wanting.

So slam the overall value of a sector to 3% of the S&P 500, and it becomes a nuisance. Well actually neglected, as thinking it to be a nuisance means you’d actually have to care about it. Most don’t, so neglect it is.

As an investment analyst, follow a neglected sector for long, and you can watch your career die. Besides, there’s no investment banking fees to be had, so why even bother. Similarly, it’s a trash bin of companies with terrible capital management, so if anything you can short it. Over the long haul, if there’s a way this sector can torch capital, it’ll find it.

So we’re left with 3%, and when the current energy crisis struck, there were fewer analysts to cover it, let alone to understand it. The only group remaining were those who’ve been buried in the sector for so long that they can instantly recognize the crisis for what it is . . . not short-term.

Others though will look at the futures market for confirmation. See? It’s predicting a cheaper price in the near future. Just look at the chart from Javier Blas.

$70/barrel by December! All will be well. Well . . . that’s not quite what it’s saying, but okay. Who are we to quibble, we’ve only been doing this for years.

We are the 3% after all.

The one great thing about social media (and especially Twitter) is the near instantaneous expert commentary (real or otherwise) that appears whenever a novel issue breaks out. As the US/Iran War wages on, market generalists have freely opined on geopolitics, military strategy, energy flows, and the nuances of the oil market. Aided by their preferred AI agent, the analysis has been delivered quickly, boldly and confidently.

This won’t last long they say, it will be painless, and once the Strait of Hormuz (“SoH”) is reopened, oil prices will plummet below the levels seen in pre-conflict. A peace dividend for all.

Frankly we don’t know. We don’t know what the day after will look like, the Day 1 after the all clear sounds. Can it end on April 15th? When Trump’s “2-3 weeks more” nears its end? Will Iran let him walk away, and reopen the Strait? As of now, we’re not entirely sure this thing doesn’t go far, far longer.

As this war drags on, the global energy situation will worsen. This is a 10-11M bpd deficit, and it will quickly carve-up the world. There will be the haves and have nots, those who can afford the exorbitant prices, and those who cannot. Those who produce energy domestically and those that do not. Third world and emerging markets like the Philippines, Thailand, Vietnam, Indonesia are going to feel the pain, but eventually that pain will migrate to Europe, and then the US.

Here’s some of the items we’re thinking through as the pain spreads, and why we think the pain lasts longer:

1. TACO - Trump Always Chickens Out works when things are unilateral (e.g., self-imposed tariffs), but in a war, it takes two to TACO and Iran has little incentive to eat and soothe the pain for the Trump Administration. This will drag on.

2. Abandon the Strait - Impossible. It would represent not only a strategic and tactical defeat for the US, it would subjugate Saudi Arabia, Kuwait, Oman, and the UAE to the whims of Iran in the future. Iran would effectively control nearly all oil flows out of the Middle East. In addition, given that China purchases most of Iran’s cargo, and Russia provides significant support, guess who benefits and gains further leverage behind the scenes? If the US was unwilling to let China gain an economic toe-hold in the Panama Canal, what makes you think they’d let Iran become a toll-taker in the Strait of Hormuz? Walking away isn’t a viable option.

3. Existential Threat - By removing the Iranian leadership and attacking Iran’s infrastructure, the remaining members of the IRGC know that this is a fight to the end. There’s little daylight to negotiate when everything is on the line, and they know the US/Israel could attack again in the future. If it’s a choice between our lives and your global livelihood, they’ll bet on the world blinking. This effectively extends the conflict and forces participants up the escalation ladder until the pain becomes unbearable.

4. The Price Gap - few appreciate the magnitude of this deficit because the prices aren’t accurately reflecting it. Whether it’s the jawboning, or the belief that this war can end immediately, there’s plenty of reasons for skepticism. Ironically, the artificially lower prices actually forestall real conflict resolution, and in fact allows the US and Israel to press their attacks. This reinforces the market’s optimism because all they see are successes of targets being bombed and the tweets about Iran’s inevitable capitulation. The war, however, continues, and the SoH stays blocked. Yet, since the back of the curve is at $70/barrel, then surely we’re fine? We are not.

5. SPR - the Strategic Petroleum Reserve releases aren’t a salve. It’s a bandaid on a bullet hole. The volume is insufficient, and the value is questionable. At full capacity, we think the SPR can release 2.5M bpd against a 10-11M bpd global deficit. In addition, much of the 400M barrels of SPR release (e.g., US’ 176M barrel release) was designed as a loan so refiners would need to pay back the loan at a later date with interest. Refiners are balking at that currently so the uptake on SPR barrels have been tepid. Eventually though, if there’s not enough barrels outside of the US, you can surely bet that US exports will ramp higher.

6. Immediate return - there’s a perception that once the SoH is reopened the barrels will quickly return. Logistically given sailing/discharge times, we put that at 2 months. So even if the war ended today, it would take 2 months to sort out the logistics of transportation, and for the first barrels to show up. The delta between supply/demand will shrink as the weeks move on, but we should expect inventories to fall further even after a ceasefire and detente is declared. Having said that maybe . . . and just maybe the curve is correct. It’s expensive today, but if it clears up, prices should fall, but stay elevated for a few months, and then head lower, though still remaining in backwardation, and still much higher than before.

7. Inventories - there’s also a perception that because there’s so much inventories on land and on-the-water, we can easily drain and handle a 1B barrel drawdown. That’s an illusion. If we continue this war until mid-April, we’ll have exhausted a significant amount of oil-on-water, and land inventories. By the end-of-April, analysts anticipate that close to 1B of barrels of oil are lost for the entire year when all’s said and done. This isn’t unreasonable given the 10-11M bpd of shut-ins, coupled with a slow logistical return. None of this is taking into account any damage to field integrity, etc. for oil fields that have been shut-in for so long. Kuwait estimates it would take 3-4 months to bring production back online. Hardly surprising as you’d need to repressurize the field and conduct tests.

For the time being, inventories are draining from oil-on-water first as the physical air pocket increasingly impacts other regions besides Asia. As the last oil is delivered, watch inventories on land drop precipitously. We’d expect to see product stocks fall first, and then eventually crude. For some OECD countries like Japan, they’ve already stopped publishing data on product inventories, which tells you a lot about the direction of their reserves already. Europe is next.

Sum it all up right now, and the charts don’t look that bad. The issue though is its early stages, and the data lags a bit. We’re most definitely hemorrhaging inventory here, and it’s only just beginning as the Western world will begin to see the impacts this coming week. The data’s starting to trickle in, but doesn’t fully capture the lost barrels. The irony is that the US, whose actions are causing the closure, will feel it last and likely feel it least. Inevitably though, energy is a global commodity, and despite being a net exporter, US prices will catch-up.

We believe the oil price curve is completely mispriced here given the duration and quantum of outage. A $5/barrel bump at the back end of the curve doesn’t adequately reflect the lost barrels. If anything, the minor bump represents hopium that immediately after reopening we return to past.

We completely disagree. Geopolitical uncertainty, inventory depletion, and supply balkanization/uncertainty moving forward means longer-term oil should be somewhere near $90/barrel even if the war were to end today. Given that it is not, and on track for another 2-3 weeks?

Expect triple digit prices to stay. Especially if the US does send boots on the ground (our base level assumption), and their stay isn’t short (also our assumption).

So price oil at the back end at $70/barrel (and energy equities too)?

We’ll see you on the other side of that trade.

God Bless America and our troops.

After a month of conflict, we can all assuredly agreed that the Iranian excursion was at best . . . ill advised, and at worst . . . well . . .

So we wait for the weekend as special forces (Tier 1 operators), a Marine Expeditionary Unit (“MEU”), the 82nd Airborne, land based fighters and bombers, and coalition forces assemble to capture some of Iran’s islands in an attempt to unblock the straight.

Will they succeed? Absolutely.

Tactically that is.

The tactical/military superiority of the US armed forces can’t be denied. They’ll almost certainly take whatever land, air strip, port, or oil infrastructure they set out for, and with minimal casualties. Of that we’re fairly certain given the poor training and degraded Iranian capabilities.

What we’re uncertain of though is whether a quick strike and victory, necessarily gives the US sufficient leverage in its negotiations. Negotiations that are seemingly getting more desperate by the day.

Among the few options floated include taking Iran’s strategically located islands in the Persian Gulf.

First, the US could take Kharg, Iran’s oil export terminal on the top left hand corner of the map above. Second, it could take Qeshm on the bottom right. Kharg, a major export terminal would be beneficial as it would shut-down the main spigot for Iran’s oil exports. Iran can divert its supplies, but not as easily, and not in full. Yet if the US was already willing to unsanction Iranian oil for fear of harming the oil market, it’d be inconsistent to then capture Kharg, and jeopardize flows there. Still, in trying to gain leverage, capturing Kharg would be the way to go. It’s much further in the Persian Gulf though, so would require a longer logistical tail to hold, which increases the military risk. Kuwait or Saudi Arabia’s assistance could help as they could resupply the troops from there. Still though, would the US be willing to completely shut-off flows when oil is already impacted? We’ll see.

Alternatively, the US could capture Qeshm. Currently, Iran is demanding that the US recognizes its right to control the strait (one of a list of 5 demands), and it’s using the waterway between Qeshm and the mainland as a toll gate. Capturing Qeshm would deny the Iranian’s the ability to use the facilities there. Issue with Qeshm? As you can see, it’s much larger. It would also likely mean ground operations in Bandar Abbas, and that means you’ve landed boots on Iranian mainland soil, which will take the entire war up the escalatory ladder.

Would it Matter Anyways?

Regardless of what the US does, what doesn’t immediately disappear is the asymmetrical threat posed by the Iranian drones and mines. If so inclined (and able), Iran can send enough drones to overwhelm the naval escorts when they cross the strait and/or at least pester the commercial tankers. Even if the escorts were successful, the disruption, logistical burdens, and insurance/economic costs likely means only 20% of the original traffic can be restored. Here’s Vice Admiral Kevin Donegan of the US Navy (in an interview with Goldman Sachs).

20% of normal flows? That’ll hardly make a dent in the supply outage.

Besides, we’re skeptical that sending boots on the ground means the Iranians will quickly capitulate as they only need to drag the war out for another few weeks. If Iran can keep the strait closed, or materially disrupted for 2-3 more weeks, we believe the global economy will come crashing down, deterring future aggression from the West.

So would they be willing to sacrifice a tactical loss for a strategic victory? Yes.

Today, we continue to have nearly 10-11M bpd of production shut-ins. Exports through the Strait of Hormuz are down by nearly 15M bpd, and SPR releases are just beginning. Despite accounts on Twitter sharing that some vessels have passed, it’s a far cry from the norm. Vessels traversing the strait are the exception and not the rule.

More importantly, production shut-ins are topping 11M bpd, and will take weeks if not months to fully come back if the war were to end today. You think we can last? Asia is already in full emergency mode:

1. Philippines - have declared a national energy emergency program, 4 day work weeks, and directives to limit travel and reduce power usage

2. Thailand - mandatory work from home for civil servants, strict air conditioning settings to save energy and subsidizing product prices;

3. Pakistan - 4 day work week for government offices, closed schools and cut fuel allowances

4. India - restricted LPG usage to ensure supply to households

5. Sri Lanka - limited fuel purchases and made Wednesdays a holiday for fuel consumption.

6. Japan - suspended public reporting of product inventories and intervening in the paper market to suppress prices. Restricting exports of petroleum products.

7. South Korea - implemented petroleum price caps and public energy savings program.

8. Australia - introduced export curbs on refined products (the country imports roughly 80-90% of its petroleum products). Relaxed fuel specifications.

Note that this is this week only, and countries are beginning to buckle. Even if the war were to end today, it would still take weeks to restore product flows and transport crude and products to the impacted countries. By next week, Europe will begin to feel the pain as the tankers that would normally show-up don’t.

This slow-rolling outage will accelerate in the coming two weeks, and by our estimates, if a resolution and immediate resumption of supplies doesn’t occur, we’ll have lost so much inventories (i.e., ~450M barrels) that inventory reserves will be depleted and prices will begin to moon. Any longer, and the scarring will be severe. Energy Aspects estimates if the outage lasts until the end of April, we’ll collectively lose 920M barrels of liquids. That my friends is nearly unfathomable.

Complacency

As of Thursday’s close, the SPY and QQQ are down only 5.6% and 6.4% year-to-date, respectively. Trump’s back and forth about striking and not striking energy targets in 5 day, and now 10 days, has flip flopped the market. After each TACO though, the market rallies are getting weaker, and oil prices have fallen less. It’s a dangerous indicator that the TACO-ing is becoming less effective. The paper market can be fooled, but the physical market is starting to discipline as the molecules just aren’t there.

Unfortunately, unlike the US’ unilateral tariffs, it takes two to TACO this time, and will Iran bite this time? Only to give up all of its strategic advantage just when the leverage will soon swing decisively in their favor? Only to negotiate with a Trump Administration that has already burned it twice (i.e., attacking during negotiations)?

We’re doubtful.

The nuclear option outside of developing a nuclear weapon was always to weaponize the Strait of Hormuz. It was simply unthinkable because of the global consequences. Who would decide on such a pyrrhic strategy? Apparently, someone facing an existential crisis.

They’ve finally done so, and that missile has been fired directly at the global economy. So fool them once, shame on us. Fool them twice? . . . they’ll let it burn.

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(Disclaimer, we hold plenty of energy equities, USO/BNO, and shorts on select tech companies. Due your own due diligence, but for the love of all that’s good . . . be careful out there in the coming days.)

Just not today.

We’ve stepped into Iran’s hurt locker, and now enclosed, we’re still swinging away.

Doubling down because that’s what people with strength do right?

So the USS Boxer joins the USS Tripoli and its MEU in the Gulf. We won’t speculate what the MEUs will be used for (e.g., Kharg Island or the shoreline next to Strait of Hormuz), but just simply look at timing. It takes about 3 weeks for an MEU to sail from the West Coast to the Gulf. USS Tripoli will arrive before that (sometime next week), but even if it’s successful in gaining a tactical victory and taking a strategic foothold, would that compel the Iranian’s to lay down and accept a full ceasefire and peace accord? Doubtful, which means this excursion likely drags on for another 3-4 weeks.

We doubt it because by the end of next week . . . we’re bingo fuel.

What we mean by that is we’ll have effectively wiped out the entire “glut” built last year. Moreover, we’ll be dipping into commercial inventories, the draining of which will make oil gains go parabolic in the West.

Oman is at $170, Dubai at $150, Asia at $150, Europe is at $110, and the US? $98. Whew . . . only $98. Don’t exhale though because it’s coming. A slow zombie horde of undead prices. Here’s JP Morgan.

Next week, oil prices will creep higher as the shut-ins continue and supplies falter. Despite the tumult, the S&P 500 and QQQ are only down 4% year-to-date. This insouciance will allow the administration to keep wandering down its chosen path. Fair enough, but every day this continues, means another dollar added to the back of the curve when oil supplies resort themselves. We think even if the all clear sounded TODAY, we’re looking at $80/barrel oil when the fog-of-excursion lifts. If you need marines to land and force a capitulation in three weeks? Triple digits. Goldman agrees . . . higher for longer.

So what’re we doing about it? Well, let’s just take a quick look at Occidental Petroleum (“OXY”) and one of our holdings, and how we’re positioned for the above.

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We’re trying to desperately find one, but the consequences are all unpalatable. Declare victory and walk away? Strengthen the enemy long-term. Give up? Never. Deploy the full power and might of the US armed forces? Embrace the tar baby. There are no good choices right now.

This was one of the worst strategic blunders, made on the basis of hubris, supported by faulty information. For months, the investment community and government agencies were peddling analyses that we were witnessing one of the greatest global glut in oil ever. JP Morgan, Goldman Sachs, the IEA.

Nearly everyone.

The IEA anticipated a 2.3M bpd build in 2026. Goldman came in below that at 0.8M bpd.

This narrative was so pervasive it stuck. So armed with wrong assumptions, and fresh off the back of a successful Venezuelan regime change, Gaza takeover, Hezbollah decapitation, and global economic arm-twisting, we ventured forth to pursue regime change in Iran. Quick and easy right? This my friends is the very definition of FAFO.

So here we are today, one where oil prices are ticking higher as the war, err excursion, no wait excursion to prevent a war plays out. Whatever this was/is, it’s a bad trip. The US can and has easily achieved some tactical victories, but strategery-wise? Not so much.

Since we last wrote, oil prices have climbed from $85/barrel to $120/barrel, only to have fallen back to the current $95/barrel level after President Trump shared that this will be a “short” war, and that Iran’s military capabilities are being materially degraded.

Fair enough, the market immediately sent oil plummeting to $80/barrel. In addition, the IEA in coordination with various countries decided to release 400M barrels of oil from their strategic petroleum reserves (“SPR”). In the US’ case, 173M barrels, to be available next week (for refiners to bid), and to be delivered over 200 days. Since SPRs in every country can’t deliver more than 3M bpd combined, we’re not sure how that fully offsets the nearly 15M bpd currently lost.

Even as these salves were prescribed to ease the market’s discomfort, Iran began mining the Strait of Hormuz and attacking ships anchored in the Persian Gulf or attempting to run the blockade. The escalation quickly eroded the market’s confidence that all is well, and that all of this will be completed in short order. Accordingly, oil prices have risen again.

Financial Impacts

The broader market though, has largely shrugged off this whole episode. For the most part, it’s flat. Sure there’s significant volatility, but here’s the performance of the indices since the beginning of the our excursion on February 28 to March 13:

S&P 500 -2.5%

Nasdaq -1.1%

Russell 2000 -4.8%

Other than the Russell 2000, the broader market has largely shrugged off these attacks despite the disruption to oil, petrochemicals, fertilizer, noble gases (e.g., helium in semiconductor industry), etc. Arguably, the US is better positioned to weather the energy supply shortfalls, but with its just-in-time supply chain, eventually the inflationary costs will rebound as manufacturers worldwide struggle with shortages and higher energy prices. The supply chain can hold-out for a brief pause, but as the days roll-on the damage gets increasingly exponential and calcified.

We think the market’s overly complacent here. The buoyant stock indices mean the market is predicting a rosier future, one where energy prices might come out of this whole debacle actually lower.

Is that possible? Maybe. Maybe if the US cowls Iran . . . but man-o-man, that sure seems doubtful right now.

What we do know is that each day the market fails to fall, it further grants Trump carte blanche to continue his attacks unabated. In turn, the longer the attacks continue, the greater the harm done to oil supplies and oil prices in the future.

That’s the calculus. It’s the US vs. Iran vs. the stock market/global economy. Who will capitulate first?

So let’s level-set again. Oil exports out of the Strait of Hormuz runs about 20M bpd. ~150 vessels of all types (i.e., petroleum, container, agriculture, etc.) traverse this 22 mile channel. It’s shallow, so the crossing corridor is only about 3-4 miles. Surrounded by mountains, Iran has numerous places to launch drones both in the air (UAVs) and water (USVs) to disrupt the flow of traffic. Tack on mines too (buoyant, rising, CAPTOR (torpedo launching)), all deployed from fishing trawlers, or dhows (junk trading vessels). There’s thousands of those, so deconflicting the area will be difficult.

Plus, it only takes one hit to ratchet up the economic costs. One drone getting through, or one mine causing damage means the whole market gets repriced. Even a minor disruption can be material. If 150 vessels a day transited the SoH, what happens when only 130 do? Isn’t 20 still a material disruption?

From purely an oil perspective, let’s do some math on what’s actually happening. 20M bpd of oil flows through the straight. A few hundred thousand to about a million barrels are still flowing as Iranian exports to China continue. The Saudis have also reversed a pipeline that runs East/West and can potentially redirect 5-7M bpd there, so the disruption is around 14-16M bpd.

The oil isn’t entirely lost though because if the artery is plugged, producers can shunt it to storage for a limited time before they have to shut-in their fields. Unfortunately, the IEA reports that ~10M bpd of production is currently shut-in as storage tanks are getting closer to full capacity. Note that this is the most important figure because it’s the real production that’s lost. So take that 10M bpd and multiply it by the number of days, and you’ll start to see some large numbers. 100M barrels in 10 days alone, 200M in 20 days, and that’s not even factoring in the delays if/when the US and its allies can reopen the strait and how long it takes the ships to get refueled, repositioned, and sailing again. Ripple that through to inventory balances, and assuming 1/3 of that impact shows up in IEAs inventory figures, and you suddenly get a base-line of $90/bbl (i.e., the price oil should fall back to once all is said and done).

It’s the difference between a hiccup in your supply chain vs. a real supply shock. Stock-outs are what we’re worried about, and life is coming at us fast.

Prolonging the stock-out though is effectively Iran’s strategy. It’s two-fold right now,

1. Deterrence - make this endeavor so costly that strategically, the US, Israel and any other ally will be deterred from attacking Iran again;

2. Resilience - no matter what you do, this regime will survive. More importantly it can survive longer than the stock market and global economy can hold-out on such a large supply disruption.

Unfortunately for Trump and investors betting on a TACO (i.e., Trump Always Chickens Out), the timeline this time isn’t entirely in his control. For the most part, the clock is ticking, but that clock isn’t controlled by the West. The longer this lasts, the higher the economic pain, and it behooves Iran to keep testing that pain threshold. Closing the SoH, or even threatening to close it, gives them the ultimate leverage in any negotiation. Attacking oil infrastructure through the Middle East also encourages the Saudis, Kuwait, Qatar and the UAE to call on the US to bring about a ceasefire/truce on terms favorable to Iran.

Oh wait, they know that.

So for Iran, each missile launched, each drone sent, is an invitation to their hurt locker. Spread the pain and really test everyone’s resolve. The desire to exact revenge and retribution will also drive Iran’s thinking. While it has been weakened, and not immaterially, it knows that this battle is existential, and if they’re playing the trump card of closing the SoH, it better be for a larger pot.

Kinetic Affects

As the US and its allies are still marshaling naval and ground forces in the region, it will take another few weeks before a proper military escort can begin to break the blockade. In fact, likely month-end.

Tack on the repositioning of combat troops and we’re looking at least another few weeks.

Our rule of thumb is that oil prices will rise $1/bbl, conservatively, every day this excursion continues if we assume 10M bpd of shut-ins (i.e., real production lost). What we mean by that is every day the SoH is closed, equates to about $1/bbl of premium when we “return to normal.” If everything gets sorted by month end, we think this is what inventories and oil prices will look like.

Any longer than that, and we’re rebasing higher. Two caveats: first, there’s bound to be some demand destruction as oil prices climb, airfares getting expensive and road trips not taken, but the world can likely keep calm and carry on for a few weeks (so we’ve disregarded that for purposes of this exercise). Second, you’ll notice that in the chart oil prices have previously dislocated from inventories since mid-2024. That’s largely because of the calls for “inventory gluts,” etc., so tack on whatever discount to the $90/bbl fair value you think is appropriate (i.e., the discount that you think will “survive” even after this debacle). Suffice it to say if oil stuck around in the $80s after kumbaya breaks out, oil companies will print money (they need to if the world wants producers to increase production).

We don’t know when this will all end, it could end suddenly and oil can plummet, but what we do know is that the US is beginning to manipulate oil prices . . .

. . . and trying desperately to find a palatable political narrative . . .

All of these shifting statements and market manipulations will prevent real price discovery. It’ll deter producers from drilling and pumping more because of the potential volatility. Furthermore, it prevents the market from responding to the real shortage, and shifting enough capital to address the issue, which will inevitably exacerbate the issue.

Ultimately, selling financial paper and lowering prices via press statements can suppress oil prices for a bit, but the physical always disciplines, and the Iranians know that.

Again, this is a race against the clock, but the Iranian’s are holding the watch. The longer this lasts, the higher oil climbs.

Welcome to the hurt locker.

Iran’s one of those topics where we have a lot of opinions about, but very few convictions in with the uncertainty so high.

As the US engages in “offensive operations” against the country, we’ve just started Day 6 of this conflict. Iran’s now effectively blocked the Strait of Hormuz, a small maritime chokepoint in which 20% of the world’s crude oil flows. It’s not only narrow, but fairly shallow in certain areas, so even in the best of times, it requires careful coordination when moving VLCC behemoths in/out of the Persian Gulf.

Lob a few drones at anything that transits there and you effectively plug it. Lest you’re a daring owner cut from the same cloth as Jack Sparrow and you run your tankers at night with your AIS turned off to break the blockade, most will stay away. Still that’s a lot of risk to take, and for most multinational shipping companies, one they’re unwilling to take even if you give them adequate insurance coverage. Sure the US can backstop shipping insurance all it wants, but will they also cover the lost income if an Iranian drone sinks a ship? Unlikely. Will it cover the replacement value or the ship, or the fair market value of the ship? Who knows.

So thus the strait likely stays closed unless international pressure forces Iran to reopen it, well really the IRGC. For now though, that pressure won't come from Iran’s largest customer, China, because guess who’s still allowed to transit the passageway? That’s right, good ‘ole Xi Jinping, and everyday this “operation” continues, Xi gains increasing clout. Besides China, no one else is willing to transact with Iran today, and later when the country needs to start rebuilding, guess who’s at the front of the line for those contracts. So yeah, the strait’s closed . . . but not to China.

Shutting-in Supplies

Oil prices have vaulted though due to all these shenanigans. Climbing from $73/barrel on Friday to today’s $84/barrel.

That’s 15%, give or take, and it’s just the beginning if the situation persists. How high really depends on how long this goes. The longer the strait is closed, the more storage facilities in Saudi Arabia, Iraq, Kuwait, and the UAE fill-up. Once those tanks are filled, then production shut-ins start to happen.

Iraq has already announced a cut to oil production of nearly 1.5m bpd. If that doesn’t sound like much, Iraq produces 4M bpd, so yeah, that’s plenty. It’s inevitable though because spare storage is finite at ~300M barrels in the region. So by 2-3 weeks time, we’ll fill those puppies to the brim, and then force the fields to idle.

In turn, that shut-in translates to an increase to oil prices by $10 to $15/barrel for the month, so think $85-90/barrel for Brent. In the short-run, it’ll almost certainly exceed that if we cross longer than 10 days . . . and we’re nearly halfway there.

The market though (as represented by the S&P 500) has been fairly nonchalant.

It’s barely down in the past 5 days, and it’s almost certainly looking at a TACO scenario whereby Trump Always Chickens Out. It’s willing to overlook the near-term rise in oil prices (we are after all “glutted with oil”), and the temporary bump will not only prove fleeting, but even more encouraging is that once the Iranian populace revolts against the IRGC, we could see oil prices decline even more as the vast production potential of that country is unleashed.

Never mind the political uncertainty a toppled IRGC will lead to, or the sectarian issues that’s deeply embedded in that region. No doubt 100K former radicalized IRGC members will blend quietly back into a new cosmopolitan Tehranian life, and all will be well.

Call us doubtful.

Still, this is the path we’re on. Despite the rhetoric of the administration, this endeavor doesn’t appear to be fully thought through. The administration is likely counting on a quick capitulation. Flush off the success of Venezuela, the surprise surgical strikes in Iran should bring about a regime change as protesters reappear. Our good deed in Venezuela worked, so no doubt it’ll work in Iran. Moreover, oil prices shouldn’t rise too much right? We have nearly 4M bpd of spare capacity AND a super-glut of inventories, so the oil market will stay calm. We firmly believe that’s what they believe, and as you know, we firmly believe that it’s wrong.

So based on these faulty assumptions, and limited past success, we’re off to the races in wiping out the IRGC leadership. It’s regime change we’re after, so it’s existential for the IRGC. So surely, they’ll go quietly into the night.

Yeah right. There’s no way. Iran will continue to lash out at its neighbors and ratchet the pressure on the global economy. It certainly knows that the longer it can last, the better it will survive. The US can only continue its operational tempo for so long. Given the sheer distance and the vast size of Iran (i.e., larger than Alaska, and more than twice the size of Texas), the ability to project air power is finite as men and machines invariably wear down. There’s also a plethora of hiding places in the mountains for Iran’s weapons, and they’ve no doubt become adept at shooting and scooting.

So bear down and survive. Iran knows there’s two things that can end this conflict . . . the market and munitions.

Munitions & Markets

The market’s patience, and dare we say complacency, is limited. Continue to block the strait and eventually oil prices will leap so high that demand destruction (i.e., a recession) must follow. It also isn’t just the Strait of Hormuz that’s the issue, Iran’s attacks on lightly defended refinery complexes in the region also shuts in production. Saudi’s Ras Tuna’s refinery (550K bpd of processing), Kuwait’s Ahmadi refinery, Qatar’s Ras Laffan LNG complex, and Bahrain Petroleum Company’s Ma’ameer refinery (400K bpd) have all been targeted. Attacks and repairs halt production, which increases the need to reroute or store the incoming crude. Damage enough infrastructure and you’ll force producers to shut-in production. Translation - everything and anything is up for grabs, my pain is your pain.

The cumulative impact is real. The longer the conflict goes, the more the pressure grows. If energy prices vault as a % of GDP (as it did in 2022), it will cascade the market.

Trump ties his personal and presidential success to the stock market, and if the real time report card starts to slide, then the odds of a TACO Tuesday ramps higher. What isn’t clear though is what happens after. Can he TACO if the IRGC remains intact. Can he even TACO at all?

He can certainly declare “Mission Accomplished,” but like the ill-fated Bush declaration, the knock-on effects of an even more dangerous and now betrayed Iran grows. Good luck negotiating with that, and we all better tighten our borders.

Munitions is the second issue. Eventually, the US will run low on stocks (both offensive and defensive weapons). In fact it already is.

It’s started shifting missiles from Asia to the Middle East, which tells you what inventories are really like for the US and its allies. Missile stocks are quickly dwindling given the sheer number of threats. Just today Bahrain intercepted 75 missiles and 123 drones in a refinery attack, but can it do the same the next time? Even after downing so many weapon systems, the refinery was still struck. What of its other neighbors, or even more lightly defended targets? As inventories fall, drones and ballistic missiles will start getting through with increasing frequency despite Iran’s lower launch rates. So it’s a race between finding and destroying the launchers vs. the rate at which defensive missiles deplete.

Tick Tock

Regardless of what happens, there’s a ticking clock here. The longer this goes on, the more pressure the US will face to cease hostilities and look for an offramp. Product prices (i.e., diesel, gas, jet fuel, etc.) are already roofing as refineries are taken offline (either because of lack of crude supplies or refinery attacks), and as prices climb at the pump, political support will degrade further. Inflation was already one of the largest issues in the upcoming midterm elections, and that was before energy prices climbed higher.

For Iran? The calculus is much simpler. Just-in-time refinery operations worldwide provide little to no resilience for our global energy market. As their attacks persist, as they continue their oil blockade in the strait, even for a short while, the market shock will force the US’s hand. Sure OECD countries and non-OECD countries will likely release supplies from their Strategic Petroleum Reserves (“SPR”) in short order, but if Iran is disrupting even half of the flows in the Strait of Hormuz, the 10M bpd loss will still be quickly felt worldwide.

We’re on Day 6, and thus far this is an energy shock, and one the world is unprepared for if it crystallizes and far too complacent about. So said another way? We think this has to go higher for the economic pain to be real. We have to go risk off before we can dial the risk back. Markets are like people in that they only really change when the cost of something becomes far too great to bear.

$84/barrel today just isn’t there yet, so the beatings will continue . . . until morale and oil prices improve . . . and they likely will.

That’s the rough figure we use for Occidental Petroleum (“OXY”), a company we’ve been holding for a bit. This one’s been in the dog house for awhile after recently closing the CrownRock acquisition and selling its OXY Chem division to Berkshire Hathaway. The stock’s languished as oil prices trended lower in 2025. Having shed $10/barrel from $70 to high $50s, OXY similarly sympathized and fell by $10/share, give or take.

So $10 x $10. The’s ur rule of thumb. It essentially means that for every $10/barrel oil price moves, we’d expect (all else being equal), OXY’s stock price to move $10/share. 10x10.

10x10 . . . well that is, until this quarter.

Because finally, we’re getting some traction.

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It’s something I have saved on the desktop. Nothing obnoxious, it’s unobtrusive, but it’s there.

I’ve had it for awhile now.

I’ve seen it repeated, many, many times, and in many places.

Sometimes on the things I own, sometimes not. Fortunately, not so many.

The chart doesn’t always repeat, but in Mark Twain’s parlance, history sure does rhyme.

That’s not surprising though because human nature isn’t surprising. We get bulled-up, we get excited, and we get greedy. Then the euphoria rips, and the grifters grift. The institutions legitimize it and the investors harp it. The media focuses on it and retail gets swept up in it.

Then . . . and only then, is when it tips, and when it tips, is when we all get nervous. Michael Burry it seems, senses some nervousness (his chart below for Palantir).

For some, nervousness lends itself to bravado. “I want IT to crash, so I can buy more!”

. . . no you won’t.

Nervousness lends to seek answers “What do you see in the charts? Where’s it headed?”

. . . I don’t know, but maybe down?

Nervousness leads to questions “Why isn’t the management team defending the price?”

. . . they were busy selling.

. . . and buying things that surely speaks to the revolutionary nature of what they’re doing . . .

It doesn’t matter though.

We don’t understand it. All the US government contracts, all the software platforms, Gotham, Foundry, AIP, and Apollo. Awesome game-changing, face ripping, sweet-mother-of-GOD dashboards and tools that allow companies to manage their supply chains, detect financial fraud, and hunt terrorists . . . simultaneously.

Such an endeavor cannot possibly be valued because we simply can’t comprehend the types of services their consultant (nay . . . “Forward Deployed Engineers” (“FDE”)) provide. Got it?

No sir, these FDEs are embedded with clients and mission driven to engineer solutions to tailor Palantir’s proprietary platform to the client’s unique data-set.

Isn’t that what most consultants do?

Fine. Maybe we don’t get it. Maybe FDEs and their crack sales teams are AI ninjas that provide so much value that they can simply turn over random rocks to find billions of additional revenue each year.

Heck, let’s growth them at an even faster rate than today. How’s 70% to your liking? More than the 60+ they’ve been doing. Let’s be more aggressive because we simply don’t know. 70% every year for the next 5 years. How’s that look?

By the end of 2029, we’re looking at $37B in revenue! Quite honestly, amazing . . . but even if the stock doesn’t increase from the $135/share today, it’s still nearly 10x revenue. Again we go back to Scott McNealy’s quote reminiscing about the 10x revenue multiple investors were willing to pay for SunMicrosystem’s stock at the height of the internet bubble in 2000.

People today? Hold my beer.

. . . 72 TIMES REVENUE. Oh wait but that’s trailing 12 months. What of 2026?

Fine, 43 TIMES REVENUE.

Feel better?

Or do you feel nervous? Because again, take a look at this chart.

THIS. DOESN’T. INSPIRE. CONFIDENCE.

There’s an air pocket there. An air pocket in which the oxygen’s dwindling, and the fear is increasing. In all likelihood, fear will become extreme, and in time fear will turn to capitulation.

“It’s already fallen so much . . . I might as well keep it.”

When momentum shifts, then the cascade really begins as traders press it lower. Longer-term investors will hold though. They always do because of anchoring bias. Well actually every psychological bias kicks in, creating a toxic stew of stupor. So most won’t sell, most will hold. HODL they say.

Eventually this may all turn into despair and dismay. There’s few natural buyers in the wasteland. Very few who’d step-in to catch a falling knife. Perhaps a bit lower, some compounder bros will deem it worthy enough to take a look, but that chart will make any position small. A starter position if any. If their buying fails to arrest the landing, then lower we go. All the way to the floor, where the carrions of the investing world dwell. The grave dancers, the roaches . . . the value investor. Still, that time has yet to come. That’s further down the road and much further to the right of these charts.

Maybe this’ll come to pass, maybe it won’t. We own puts on the stock and are short common shares, so we’re certainly talking our book. We’re probably wrong, but just look at that chart. How’s the bravado feeling? It’s certainly a bargain today than it was yesterday . . . at 43x Revenue.

Yeah we’re nervous too.

“I want IT to crash, so I can buy more!”

You just might get your wish.

Please hit the “like” button and subscribe below if you enjoyed reading the article, thank you. (Disclosure: Note we own June ‘27 Puts with a strike price of $95 and other instruments short PLTR shares).

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What it was instead was “blah,” and “blah” doesn’t cut it when your subscriber base is shrinking and there’s fears around the durability of your business.

That’s the market right now though, and you play the hand you’re dealt. Anything short of glorious results will get scorched, and the market certainly torched the stock sending it promptly careening 30% lower on this one. Understandable, but as we look at the underlying results, we’re wondering . . . overreact much?

Small misses can lead to disaster though. Everyone knows that, heck there’s a proverb.

For want of a nail . . . the kingdom was lost.

What’s the nail you ask? It’s basically this . . . $30M of revenue, for a company with $2.5B in total revenue. So written another way $0.03B.

Yeah, slightly more than 1%. The reason is because this is about optics and expectations. The issue is PTON has declining subscriber enrollment, and though it is profitable, the Street wants to see top-line growth. If you can’t get subscriber growth right now, at least get revenue growth since you just increased prices in October.

Here’s what the annual guidance has looked like in the past few quarters. Though we ended FY 2025 with $2.49B, PTON’s guidance for FY 2026 in Q1 was $2.45B, so down about $40M. 1% year-over-year, not great, but maybe they’ll beat it.

Relaunched product line and increased subscription prices, awesome. Revenue growth right?

Nope.

For Q2, however, PTON really clipped out and fell out. The company had guided to $675M during the busier holiday season, and unfortunately for shareholders, ended up landing at $657M, missing by $18M. That miss, and likely whatever insight the company already knows from its busier January season (think NY resolutions to get healthy) resulted in the full year guidance falling by $30M ($18M from Q2 and likely $12M in Q3), thus leading to the further reduction in full year guidance from $2.45B to $2.42B.

Again . . . for want of a nail . . . the kingdom was lost.

The $30M and heightened questions around growth led to a near wipeout of the company as shares lost 30% of their value. PTON’s market capitalization fell by nearly $700M.

Said another way the $30M miss was valued at near 25x revenue. More accurately, the value’s really attributable to the market’s lost confidence in the company (i.e., the diminished faith in the investment community that a turnaround is afoot). If you can’t grow top-line, eventually the melting subscriber counts will catch-up to you. A company simply can’t cut expenses infinitum, and profits will eventually follow where topline goes.

Yet, there’s still time. The company is free cash flow (“FCF”) positive, and the existing users still love the product. This is still a very sticky business, and even with the price increase, subscriber churn rates didn’t blow out.

In contrast to the disappointing top-line, the bottom-line metrics continue to march higher as operating margins, Adjusted EBITDA and FCF have all been guided upwards as expenses have been brought down (both in totality and as a % of revenue):

The cost reduction efforts have resulted in an increase to the bottom-line guidance.

1. Gross Profit Margin increased year-over-year from 49.1% to 53% and for the full year PTON forecasts an increase from 49.6% to 53%.

2. Adjusted EBITDA has also been increased. At the beginning of the year PTON guided to $425M, and as of today, it’s guiding to $475M at the midpoint. We anticipate the company reaches $500M as we hit Q3.

3. Lastly, FCF has similarly been trending higher, guidance moving up from $200M at the beginning of the fiscal year to $275M as of today. Similarly, we think this will eventually land around $300M by fiscal year end.

As FCF lands, debt should be somewhere in the ~$200M net debt range, and ready for refinancing in about three months (May).

So where did we go wrong?

Subscribers

Well it appears that our internet scrape data pointed at too high of a subscriber count addition. Though interest/search for the new products was high, that didn’t necessarily translate to more sales. There could be a lag effect as the consideration cycle for exercise equipment is longer, but that would be too optimistic a view to take given the aggressive promotions PTON ran during the holiday season. If performance marketing didn’t move the needle then, what happens to sales afterwards once marketing budgets soften?

So while we had forecasted only about a 40K subscriber count lost, the company delivered a 71K reduction, and that’s a significant number of equipment not sold and subscription revenue not earned. Some of this could also be a one-off impact from the higher subscriber cancellations than we modeled (we used prior price increases as an estimate). Though that could be a factor, we think the 1.9% churn this quarter was still lower than anticipated, which means that as we lose subscribers, those that are left are the “hard core” users, and thus tend to be stickier . . . which is a long-winded way of saying . . . they likely didn’t sell as much equipment.

So where does the data point to today for Q3?

Ironically very near where PTON’s guidance is for the quarter. Still that Q2 miss sure does casts aspersions on the accuracy of that tracker (though you can see it has historically been very accurate).

We think it’ll creep back on trend though because the price increase last quarter did throw a monkey wrench into the entire exercise. Moreover, if PTON is guiding to the range our tracker is seeing (with the most important New Year / January sales already under its belt), that gives us comfort it’ll meet it.

Product Sales

What’s slightly more accurate was tracking PTON’s Cost of Goods Sold (as a proxy for Connected Fitness Products Revenue assuming a 15% margin).

You can see we can land fairly close to where PTON’s end up, but since it PTON missed earnings by $20M, it doesn’t take much for a small blip to swing our forecasted numbers. We assumed too high of a COGS, which led us to assume miss on the Connected Fitness Revenue. We’ll temper that forecast next quarter.

Keys to the Kingdom

So overall where does that leave us? Well it leaves us where we started.

FY 2026, which ends on June 30th, is a reset year. We just thought the inflection would start this quarter with the introduction of the products as a catalyst. This hasn’t panned out, which means we’ll need to reassess PTON’s other plans.

The company has slashed expenses, continues to repair its balance sheet, will refinance debt shortly, and re-introduced a new line of products. H2 2026 likely sees an introduction of a cheaper PTON Tread, which will help with attracting new subscribers. Again the treadmill market is nearly twice the size of the bike market and PTON recognizes that its treadmills are twice the average price of its competitors and uncompetitive in the marketplace. Lowering the price means tapping into a larger addressable market and potential subscriber base. This likely happens in the September/October time frame, which would be just in time for the holiday season.

More importantly, investors are still waiting to see what the other new vectors for growth will be. This won’t really start until PTON refinances its existing debt in May. Once done, it’ll lift the overly restrictive debt covenants that prevents the company from pursuing M&A to flesh out the product portfolio as Peter Stern pivots the company from fitness to wellness.

Investors are currently demanding that the company slash operating expenses to pay down debt. Fair enough, but once that process has run its course, what becomes of the enhanced FCF? That should be answered in May.

Remember, it’s about a return of capital and return on capital. We need to see both as investors, and Stern’s plan needs to begin snowballing as we get into the latter half of the fiscal year. We anticipate seeing more M&A, content licensing deals, and joint ventures as PTON moves the brand into other categories.

Ultimately, experiencing this sell-off was largely our self-inflicted. While the trackers are directionally important, we placed too great of an emphasis on their precision. Sales of new equipment did indeed turn out sluggish, and PTON has now been forced to reset expectations after a banner FY 2025 where they handedly beat and exceeded expectations. It can no longer only keep cutting expenses and enhancing the bottom-line to garner a higher share price. What matters is growing the top line, and while that’s difficult, it’s exponentially harder when debt covenants tie your hands. Those knots will loosen soon, and thereafter, we’ll get a better picture of how PTON reacts after getting knocked.

Though our confidence in the path forward is tempered, we can say with confidence that the sell-off is overdone. This is now a $1.8B market cap company generating $300M in FCF, with a very slowly declining subscriber base, and optionalities to the upside.

At 3.5x market cap to Adjusted EBITDA ($500M), or 6x market cap to FCF, we’re certainly in discounted territory. Again it comes down to the perception of growth (or lack thereof) of the user base. This investment hinges on it, and the market undoubtedly thinks the company won’t or can’t deliver. Therein lies the asymmetry. If PTON and its management team can nail that, then the shares will rerate considerably higher.

For now though the market wants a nail . . . before the kingdom is lost.

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The economy’s growing, but mostly because of AI. Inflation is low, but prices are high. The consumers’ strong, but it’s largely the upper class. Contradictory notions whirl through our analysis as we wait patiently and some painfully. Have we erred, or is it oxygen deprivation? Could be both. This year we did in thinking OPEC+ would continue managing the markets instead of materially raising production to take market share. Geopolitical pressure or abandoning a failed strategy, whatever the reason, they chose a price war. So let’s all run this capital intensive and depleting sector below its cost of capital and find out what happens shall we? The resulting higher inventories, lower prices, and shale’s treadmill effects will certainly blunt supply growth, while global demand keeps rising. This’ll be fine.

It’s frustrating when reality falls short of expectations . . . for now. That’s what the younglings call “cope.” Perhaps, but it’s also the young ones that are the most ardent advocates in a bubble. This one appears to be a trap, a slow springing one. A confluence of compelling narratives buttressed by easy money. Add in a dash of real innovation, and the ingredients are there to lure a new generation of investors to believe that these are easy paths to riches, and the journey’s worth any price paid today. Never mind that the sector is replete with related party transactions and recursive investments made under the guise of developing the ecosystem. Never mind that the ecosystem becomes increasingly fragile when a customer’s ability to buy your products depends on your ability to finance them.

Capital is oxygen, and you can only recirculate it so much before the market needs a fresh tank. When valuations vault to extremes, who’s left to provide that? Investors will need more from their companies to attract the next group that’ll provide their exit liquidity. Grow revenues 50% year-over-year? The market will demand 60%. Grow 60, it will want 70. The mountain is unforgiving. So long as the weather stays fair and your narrative intact, the greater fool will come along to deliver fresh oxygen so you can climb higher. Hypoxia’s still a threat though. Each step will become increasingly perilous, and each movement uncertain. At dizzying altitudes, some climbers may begin to untether from the mountain as even their bravado fails to impress the quarterly judges. That’s when your oxygen’s cut-off.

No, we’re probably wrong. Everything will be fine.

No . . . this is a trap.

Oil Demand & Oil Supplies

As we’d written last quarter, oil inventories began building materially in Q4 as OPEC+ lifted its quotas, removing some of the last vestiges of artificial constraint on their members. What started this summer has continued into the fall, and oil inventories have moved upwards counter seasonally. No longer “managing the market,” OPEC+ members have abandoned restraint and pressed forward with production increases. So far, the inventory increases and higher oil-on-water largely mirror the increased exports from the OPEC+ members.

With their shackles thrown clear, producers gunned exports. Oil-on-water increased as sanctioned barrels met with higher exports. First oil-on-water and later oil-on-land.

The producers, save Saudi Arabia, the UAE and Kuwait, are effectively maxed out today. What spare capacity is left remains in the hands of these three producers in the Middle East, and we surmise that totals ~1.5M bpd. Still the deluge from the OPEC+ members is real, and much of it is transiting to land storage. Once they arrive, land figures will show the increase. It’s why oil prices have declined 18% this year. This is a price war, and it’s everyone for themselves.

Interestingly the increase has been less than forecasted by analysts. It’s not much of a consolation when the build is “only” 2M bpd vs. the expected 4M bpd, but it does suggests that the bearishness is vastly overdone. Current builds (QTD with January)? 0.7M bpd. What is clear is that low prices have killed US shale growth, which has provided nearly all of the non-OPEC supply growth in the past decade.

This also explains why despite the price war, oil prices have stayed in backwardation, which is indicative of higher near-term demand. So despite initially building at a pace second only to COVID, prices have not collapsed. The velocity of the build is now slowing. So is the glut real? Yes. Though much smaller than expected. What happens next? What happens after low prices induce higher demand and lower supply in the near future? Again say the phrase . . . run a capital intensive and depleting sector below its cost of capital, and let’s find out.

Portfolio Update

Occidental Petroleum (“OXY”)

Oil’s malaise in the past quarter took the wind out of OXY’s sails. As oil prices sank, OXY’s stock retreated 13% in Q4. Given we own the warrants, those declined more at 20%. At low-$60/barrel, most oil companies in the US are generating around 8-12% free cash flow (“FCF”), not particularly compelling as investments, but not financially dire for the sector. Into the $50s, that’s when FCF starts to disappear. OXY is no different, so at today’s prices, the company treads water. This doesn’t mean that the company hasn’t been furiously churning beneath the surface. After selling a steady business in OXYChem, OXY has decided to go “all-in” on oil production in the Permian. The transaction closed on January 2nd, so after the quarter ended. Following the Q3 conference call last year (and after announcing the transaction), the company provided scant details about its plans for capital returns following the sale. The market didn’t love the obscurity, and OXY will likely provide clarity in the next call now that the transaction has closed. Still the stock was left adrift with no supportive narrative as oil prices weakened in the quarter.

Despite oil’s decline, we’re expecting OXY to still generate ~$0.5B in free cash flow (“FCF”) for the quarter, and slightly over $3.5B for the year, for a company with a $42B market cap. We’ve come a long way from the days where a sub-$60/barrel oil price would’ve proven disastrous. De-levered and re-stocked, this company’s in a different place today with a much healthier balance sheet. Having said that the equity needs to move higher and soon. Either the company will self-cannibalize, and buy back a material portion of its 1B shares outstanding, or a suitor will come along and decide that the synergies involved are too compelling. By becoming a pure play producer and shedding OXYChem, OXY’s remaining businesses are easier to integrate, which makes the company a more attractive target. It’s not dissimilar to what happened with MEG Energy. Eventually MEG Energy sold above $30/share, a price last seen when oil prices reached $90-100/barrel in 2022 because the synergy savings realized from the transaction accreted to the buyer.

We think the share price today makes little sense. Someone eventually will decide to bid if OXY’s shares keep languishing. With synergy savings likely over $1B for a company of this size (i.e., slashing G&A, rationalizing redundant functions, and leveraging scale), the higher FCF is more than sufficient to cover the interest burden on the debt needed to fund the deal.

Energy companies are so discounted in the market today that consolidation is a much more affordable and less risky way to grow production than exploration and drilling. An acquisition not only increases the acquirer’s FCF, but also reduces risks. It’s cheaper and safer to buy than to build it yourself. Inevitably, a buyer will simply look at the expected cash uplift and extensive reserves, and back into the most accretive financing to accomplish the task. The path forward here isn’t just oil prices, it’s further consolidation in the patch. Either oil prices move higher, or we’ll see another round of M&A as shale producers become larger and larger.

Peloton (“PTON”) Update

The coming 6 months are critical for this company. That’s the gist of this investment. After introducing a set of new cross training equipment (i.e., bikes, treads, and row), the company’s embarked on a strategy shift from a pure fitness equipment/subscription platform to a “health span” platform, one designed to give its customers a healthier and longer life. PTON’s new strategy tackles cardio, strength, mindfulness, yoga, mental health, nutrition, etc., and is an attempt to leverage its popular instructors and platform to broaden the reach of its audience. One example is the emphasis on weight training to offset muscle loss for those who are using GLP-1s and for women who are in menopause. From a high-level perspective, the shift is important. The wellness space is a $7 trillion market, whereas the home exercise bike and treadmill market clocks in at a combined $6 billion. Yes, trillion vs. billion. Here’s an excerpt from Peter Stern’s annual letter . . .

These are all noteworthy shifts, but investors will wait until the company can demonstrate that it can steady its core business before getting excited about the new ventures. So for the time being, the company remains largely dependent on equipment sales and subscriber counts. It’s still the razor blade/razor strategy of yesteryear, and where subscriber counts go, so too will the financial and stock performance of the company until the new initiatives hit.

Since the October launch of new AI powered products, the financial press has published stories like this:

The holiday season through the first weeks of January (New Year’s resolutions) is when a majority of equipment are sold, and based on our tracking the demand was robust last quarter.

As background, holiday sales (Black Friday / Xmas) fall into PTON’s fiscal Q2 period. New Year sales will fall into the Q3 period. While Q2 sales may be good, the subscriber counts will be slightly off this time because PTON recently increased its subscription price. Prior price increases led to a subscriber loss of ~60K, but even if we factor that in, the overall results should still beat guidance.

PTON ended Q1 with around 2.73M subscribers, and we think it’ll end Q2 with ~ 2.69M, which would mean sales of new bikes did fairly well. As evidenced by aggressive New Year’s pricing, the company’s heavily pushing its Peloton Bike+ Cross Training bikes.

The above may seem like aggressive discounting, but recall that PTON raised equipment prices ~13% across the board in October. That was only a few months ago, and if we look at the subsequent pricing of the company’s products during Black Friday, Holiday Sales and the New Year, we can see the discounts are roughly the same, if not slightly less on some products vs. the “old” prices.

For the 2026 New Year Sales, it’s certainly upped the ante as the company aggressively priced the Bike+. The promotion likely encouraged customers who’d otherwise buy a regular Bike to upgrade to the feature-laden Bike+ (with a movement tracking camera, fan and larger screen) for a few hundred dollars more. By our estimates consumers were trending in that direction as the mix shift has seen a higher proportion of Bike+ purchases after the latest updates (from a 75/25 split previously to a 65/35 split today between Bike/Bike+ sales). The extra cost to produce a Cross Training Bike+ vs. a Bike is negligible, so like Apple’s ability to incentivize customers to pay a few hundred dollars more for memory, on balance this should have induced shoppers to upgrade from the base version. Bike+ subscribers should also be “stickier” because cancellation rates for subscribers who take two or more modalities are materially lower, and the Bike+ features are geared towards non-bike floor exercises.

Financially, the picture’s also improving. Last quarter we wrote:

“In totality, what we have today is a $3B market cap company with ~$460M in net debt. That’s fairly cheap for a company that boasts 2.8M subscribers and dominates the connected fitness space. PTON has recently guided FY2026 to be $2.5B in revenue, $425M in Adjusted EBITDA, and $200M in FCF. We think that’s light, as 2025 revenue came in higher at $2.5B, Adjusted EBITDA at $403M, and FCF at $328M. If you’re increasing prices by nearly 15-20% across the board (pro-rated for FY2026 as it takes effect in Q2), how’s it possible that all your metrics will be lower? We sense there’s “conservatism” in the numbers.

Since then, PTON has raised 2026 guidance. The company kept revenue unchanged at $2.45B, but bumped Adjusted EBITDA from $425M to $450M and FCF from $200M to $250M. We still think that’s light. For 2026, we have Adjusted EBITDA of $500M and FCF around $350M, for a company with a $2.4B market cap today. We think the stock should move higher once PTON demonstrates its equipment is selling well again, and the shares would need to double to match the multiples of its closest competitor.

As the company begins to refinance its debt and buyback shares, Wall Street’s hype machine can help change the narrative. Based on recent reports, the company plans to refinance its existing debt in May. By then, the company will have ~$300M of net debt (i.e., $1.3B in total debt less ~$1.0B of cash). The company’s de-levered balance sheet should garner a B to BB credit rating, which translates to a 6-7% interest rate on new corporate bonds, a far cry from today’s 10-11%. The resulting 4% lower rate equates to ~$40M of annual interest expense savings on $1B of debt. Apply a 10x multiple and that’s $400M of market cap value . . . on a $2.4B company.

Refinancing the debt also allows the company to lift restrictions on capital allocation. The current debt covenants severely restrict the company’s ability to conduct M&A, or implement share buybacks. Thus, removing these terms will give it greater freedom in generating shareholder value. Overall, the company’s executing and the new products are selling. The enormous subscriber base serves as a solid foundation for Peter Stern’s strategy to tackle wellness, health span, and mental health. We plan on increasing our position ahead of the quarter’s announcement, and believe there’s a long runway here.

Parting Thoughts

We have a barbell portfolio as we write this. We’re invested in companies that are in deeply unfavored industries, or ones with terrible sentiment, but also short companies that we think are priced not for perfection . . . but nirvana. The market loves these stocks. They’re “sexy” and can’t help but be loved on and doted over because they’re growing so fast. AI, predictions markets, gambling. Every chart is up and to the right in terms of growth metrics. The narrative is simple, limitless potential, unlimited growth. In contrast our investments pale in comparison, they’re stodgy and forsaken. We get it. No one talks to old people when babies show up at parties.

Yeah, to heck with the babies. We’re short an AI one that’s currently trading at over 65x 2026 projected revenue. 65x REVENUE. At the height of the Internet Bubble in 2000, Sun Microsystems traded at over 10x revenue. Years later in an interview, the CEO of Sun Microsystems, Scott McNally said this . . .

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”

As you’d expect, we get this question often. How can we not participate in one of the greatest advances in human history? What are we thinking? Our response isn’t that we’re not participating, we just wonder whether that needs to be today. Like the internet, AI will eventually be ubiquitous. What passes for AI today though is far below that. While the infrastructure for the AI revolution is being developed today, the technology isn’t there yet, which means there’s likely a bust following the capex boom when reality falls short. Google, Amazon, Meta, they all rose following the Internet Crash, and we’ll wait to participate in that. The market knows this, but it doesn’t care. What it cares about is growth, hype, and the velocity of capital today. It doesn’t matter if it really works . . . it works well enough. Amidst this euphoria, we look at the opportunity costs, but really wonder about the costs of the opportunity.

65x REVENUE though, ponder it for a second. The company is projected to grow revenue by nearly 40% this year. Great, 50x revenue then by year end. Tack another 40% for the following year, and we’re still talking about 35x. To get to 10x revenue, the company needs to maintain this growth trajectory for 6 years straight, selling billions of dollars of services until 2032, and only then would the multiple fall to 10x revenue (assuming the stock doesn’t push higher), the level of absurdity McNally spoke of during the height of the Internet Bubble. We’re the ones paying now as AI and easy money sucks the oxygen from the market, but what if the bill eventually comes due for those who own these things? What are we thinking indeed. Maybe we are wrong, but we don’t think so. Maybe it’s just an another opportunity to learn.

Me: That’s sure a lot of As on your report card there.

Mason: uh . . . yeah? (wisely sensing nonsense is about to start)

Me: You know there are other grades right?

Mason: Like the ones you got?

Me: Well if mistakes are opportunities to learn, doesn’t that mean I learned a lot more than you?

Mason: What IS you talking about???

Me: hahaha, you should listen to me more because I was so much better educated.

Mason: This explains a lot . . .

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A few odds and ends that we’re looking at this week as we wrap up our quarterly letter in the coming days, which we’ll publish once we send it out.

First payroll figures. Well really withholding taxes on employment income. It’s been an interesting tracker that we’ve used to see what the momentum of the economy is like. Here’s the latest update of the chart.

The logic on this one is fairly simple. Withholding taxes on employment income = employment. Sure there’s some flux b/c of pay raises, etc., and seasonality, but for the most part, it makes sense. If you have employees, employers have to withhold, and if you’ve fired your employees, then well, daily withholding should decline.

What we’re seeing is that employment appears to be weakening. These are year-over-year comparisons, so it can get choppy, but the trend seems to be clear. Certainly the government shut-down in Q4 had a large impact on private wages. The layoffs rippled from federal employees to contractors as well, so there could be some lingering effect. Government withholding is about 4-5% of the total pie, so it’s a blip in the grand scheme of things. Perhaps the ripple effects is 2-3x that in the non-federal employment sector, which could explain the recent dip.

As a corollary, job postings on Indeed.com have increased slightly, but that’s likely seasonal. Temporary labor hirings also appears to be falling, which isn’t a great sign. In total, we’ll have to see how the January and February data comes out, but as we enter the new year, employment does hint at some weakness.

To combat the economic malaise, the Trump administration will attempt to juice the economy ahead of crucial midterm elections, so that may offset. As the forces push and pull though, this second chart has us handwringing a bit.

The market? It’s expensive . . . and historically so.

Now we know, there are various reasons why the CAPE Shiller Index isn’t the be-all-end-all for indicating when a market is overvalued, but Apollo isn’t necessarily wrong here. The index supposedly doesn’t capture the value shift of stodgy old companies to the new fangled tech, and tech (e.g., MAG 7 like Apple, Amazon, etc.) should arguably garner a higher multiple given the sustainability and profitability of their businesses. Since tech dominates the indices these days, naturally the CAPE Shiller Index should be higher. Fair enough, but at 40, it can still easily fall (and has before back below 30, and even that haircut of 25% would be exceedingly painful (think 2022).

As we look at some high fliers, after crossing into the new year, we begin to think . . . what propels something that has already mooned further past the moon? When we’re already valuing companies on multiples of REVENUE, how high, and more importantly, who could, power this market higher? We don’t know, but on balance, doesn’t these things look to be at best flattening?

Perhaps the liquidity is just finding new places as memory and storage chip makers get their turn at the punchbowl.

How outlandish is this really? Let’s zoom out.

Yeah . . . insane.

If we’re mooning the stocks of companies in the very definition of heavy capex and commoditized industries, we are certainly in the very late innings of market mayhem.

Again, it’s important to remember that the stock market is not the economy, but it sure will impact the economy if: 1) we’re in a “K” shaped one where the rich are powering the economy while the less affluent are getting hammered by inflation. Guess who’ll feel the “negative wealth effect” if the market dislocates, and 2) what will happen if we hit a funding crisis if the public market gets hit? The exorbitant AI capex spend that’s currently powering the economy will slam into reverse if funding dries up in the public markets, venture capital sector, and private equity. Public markets have a significant impact in the private ones. Heck, the market has run so far ahead that it doesn’t even need to dry up, if funding simply doesn’t grow as fast, then watch out, this thing can tip over.

So two charts and a few more to mull over on this long weekend. We’re feeling cautious here as we start the year. Happy New Year, and Happy MLK Day to you all.

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Peloton Update

Peloton continues to chug-along and we’ll have more data to parse on how the quarter is going in the coming weeks. Fingers crossed in the final innings of the important holiday season. While Black Friday and Christmas are important, New Years is equally key since many people make resolutions to get fitter, healthier, and happier in the new year. Thus, purchases of exercise equipment extends into mid-January, so there’s still about a month to go in the selling season.

Current tracking still paints a positive picture, though take the graph above with a grain of salt because Peloton raised its subscription prices this quarter, and that likely induces a one-time 50-60K subscriber decline (our assumptions). Even factoring that in, we’re still ahead of guidance, and we think there’s a high chance it could come in even better than our figures. Another chunk of data should land in early January as people make New Years resolutions and commit to them by buying a bike or a treadmill (though much of those figures/economics of such will fall in Peloton’s Q3 report).

We’re at least happy to note that the treadmills seem to be selling decently at this time, and again, the treadmill market is 2x the size of the bike market, so any momentum in this space will help as newer sales pushes older used Treads into the second hand market, broadening the user base. Peloton’s treads are selling for nearly double the average treadmill price, so “seeding” and broadening this category is important. We doubt Peloton will introduce a cheaper treadmill at this stage given the price premium commanded by its products, so it’s really the second hand market that will need to do the lifting. The updated Cross Training Treads can supplant older Peloton Treads, and the latter can start trickling into the used marketplace. Currently, used Treads are selling around $1,400 - $1,800 on Peloton Repowered. Given that the average treadmill runs around $1,000, and new Peloton Cross Training Treadmills are $2,800, the “half off” category should help.

Overall the stock has had an atrocious year as it fell by ~30% YTD despite generating nearly $350M in excess cash and halving net debt.

The company will be able to refinance its remaining debt by mid-year and free itself to return capital, and invest in further growth. We don’t think the company will stay at these levels and should move higher as net debt falls to zero, growth initiatives hit and management delivers on its promises and initiates capital return.

Lululemon Update

Another company that had some interesting news was Lululemon. Recall our summer intern Matt Nakagawa took a look at the company after its share price deflated post-earnings.

Well turns out Elliott Investment Management also sees something they like. Two weeks ago, Lululemon announced the sacking of its now former CEO Calvin McDonald, after performance “nose dived.” The Wall Street Journal reported that Elliott, took a $1B stake in the company, or about 5% when the shares traded down to $160-180/share and the company was worth ~$20B.

On the topside, the company is currently valued at 2x sales ($11B/$24B), which is comparable to Nike ($46B/87B). It’s also still growing, albeit at an anemic 1% on a local currency basis and 2% on a constant dollars basis. Free cash flow (“FCF”), however, is positive. Though Nike’s reported Q2 sales figures show a similar flat trajectory, the FCF is decidedly different. Nike continues to bleed red. Holiday sales are of the utmost importance for both companies, but on a comparable basis Lululemon can still play offense, whereas Nike appears to be retrenching.

Still 1% growth means the company is stuck in the mud. Elliott’s agitating for change, having engaged former Ralph Lauren CEO Jane Nielsen to consult and potentially(?) step-in as the new CEO. She’s been working with Elliott for months and likely has a deep grasp of the problems afflicting Lululemon. So this certainly kicks the turnaround story into high gear. The brand remains solid despite the heightened competition from Vuori and Alo, and after seven years with Calvin McDonald, it’s a good time to pivot. A change of leadership and strategy could be what this company needs. It has the resources and isn’t by any means on its heels yet. Even an incremental change will supercharge its stock, so take a look and maybe pocket a few shares as a stocking stuffer. You can find it in the discount bin.

United Parks

As you enjoy your holiday season, don’t forget the fishies. About a year ago we took a look at United Parks, the owner of Sea World in San Diego and Orlando, and a few other amusement parks.

It was an intriguing story, but we actually never pulled the trigger at buying the stock as we were invested in other companies (Peloton above). After a successful MEG Energy acquisition, we exited with a dollop of cash and this one appears to be interesting again. After what can only be described as an “ugly” summer season, investors have been swimming with the fishes of late.

You’d think with the stock caving 40% YTD, there’s something existentially wrong with the business, but other than a softer summer season, we’re not entirely sure this isn’t just a market temper tantrum. The issue here is park attendance, which obviously translates to admission revenue and in-park spending. It’s been pretty flat of late, and we saw a hit to the all-important summer season as quarterly attendance fell because of 2 reasons 1) the opening of Epic Universe at Universal Studios and 2) weaker consumer spend. Given its lower price point, SeaWorld tends to attract a lower demographic of consumers, and in the current “K” shaped economy, the lower K are the one’s harder hit. It’s not so severe that we’re seeing a major downdraft in SeaWorld’s park attendance, but enough to result in a negative year-over-year comp.

So that bottom-chart above tells the difference. The “shark’s fin” just wasn’t as prominent in this year as in the past. The good news is that when the park-goers are there, they are spending more.

Yet, the company’s having to discount tickets to get them in the park, so lower ticket prices are mitigating the positive uplift of higher in-park spend. Since park costs are relatively fixed, we’re left with earnings that must suffer. Negative 10.2% for the trailing 12 months (~$700M to $630M).

Mind you, this is adjusted EBITDA (i.e., the metric management likes to use because they get to “adjust” and exclude a whole host of pesky expenses). FCF though is still hovering around $400M on a TTM basis, so management has dialed back capital expenditures to preserve cash flows.

Assuming that the holiday season is flat to last year, PRKS will still generate ~$400M in FCF, for a $2B market cap company. If you assume a similar “bad” summer season for Christmas, then we’re looking at $350M, again, not terrible for a $2B company. Undoubtedly, the company will continue to cannibalize shares at an accelerated pace especially at these levels. Shares haven’t been this cheap since the beginning of COVID, and arguably the business is much better. The next catalyst will be what PRKS does with its land.

Here’s what Marc Swenson said on the prior Q3 call:

“On real estate, we continue to discuss alternatives with potential partners and have recently received specific proposals that we are actively evaluating. As we have discussed, we own over 2,000 acres of valuable real estate in desirable locations, including approximately 400 acres of undeveloped land adjacent to our parks, including significant developable land in Orlando. We do not believe that the public markets have or are appropriately giving credit to these attractive and valuable 100% owned real estate assets.”

This is almost assuredly true, but PRKS has been slow in developing this asset and shareholders have been patiently waiting for further developments for nearly years.We think they’ll continue to slow play this front though while Hill Path compels PRKS to gobble-up additional shares, thereby increasing Hill Path’s ownership percentage.

As of Q3, Hill Path owns about 27M shares out of the 55.5M outstanding, so 49%. For all intents and purposes it owns the company, and spiking the price while it’s trading at today’s discount makes little sense. We think if the price stays here, Hill Path will likely take out the company in total, and then turn around and develop the land privately, capturing the upside itself. For minority shareholders, taking a position here would be a bet that there’s value here, and you’ll likely be able to extract some of it before Hill Path takes their ball and goes home.

The Consumer

You can see with the companies above, we’re a glutton for punishment. Most of these consumer stocks are down significantly for the year, and have been pummeled as the “K shaped” economy takes hold, despite being operationally healthy and generating decent FCF. We think they will recover, and at the current levels they’re being priced for distress when the businesses are anything but. So take a peek while you wait for Santa, they might just make great stocking stuffers.

Happy Holidays.

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